Foreign Direct Investment: More boon than bane

There is a lot of hand-wringing about whether foreign direct investment should be welcomed by India: the spectre of the East India Company and rapacious westerners still haunts us. While it is true that MNCs are often ruthless, Indians probably can compete successfully with them in a level playing field.

FDI should not be attracted willy-nilly. There are sectors where investment has been minimal, and where there could be large opportunities. For instance, despite concerns that big retailers (such as Walmart, Tesco, Metro) might spell doom for small businessmen, there are extenuating factors. Small shopkeepers may actually benefit from being able to buy good quality products wholesale from the big stores.

nvestments made by the big guys in the supply chain (for instance, cold storage and fleet management) may create a positive impact on farmers’ incomes as well as on end-consumer prices by removing intermediaries and flattening the supply chain. Technology can provide benefits: as an example, the use of mobile phones by sea-going fishermen in Kerala has created a 12% net benefit to society by removing middlemen; fishermen got 8% more, customers paid 4% less.
There is a simple economic reality that suggests that FDI is useful for India: the budget and current account deficits. Recent figures show that India’s current account deficit is 2.7% of GDP, an amount of about $53 billion. And India’s budget deficit is 5%.

Thus, if India is to continue to grow at its recent pace, the necessary investments cannot be fully generated from internal funds alone; there simply needs to be external money coming in.
There needs to be substantial investment if India’s economy is to continue to grow. FDI can account for 10-15% of gross capital formation in India, and can provide qualitative and quantitative benefits, according to Knowledge@Wharton (‘India’s Revised FDI Guidelines’), which also points out that new regulations went into effect on March 31, giving MNCs more freedom in creating joint ventures and partnerships.

The experience of China with FDI is instructive. Instead of MNCs dominating China, the reverse has happened: they were forced to transfer technology to China, and as a result, Chinese companies are now competing fiercely with the foreigners. A recent example was Mitsubishi Heavy Industries’ China venture in bullet trains; now the Chinese compete with them in new projects in Latin America.

There is also the negative fact that FDI in India has fallen by a significant amount in the recent past, no doubt because of the huge scams and inconsistent policy. The amount of FDI in 2009-10 was $36.35 billion, but it fell to $25.95 billion in 2010-11: a fall of nearly 30%. FDI is more attractive than mere portfolio investment (which has gone up), because the latter is ‘hot money’ chasing immediate returns while the former is a longer-term bet.

There has generally been a lull in FDI around the world as a result of the financial meltdown; however, India has suffered also because of the perception that policy is unstable. Policies are subject to change based on the whims of ruling parties; the experiences of Posco in Orissa, of Coca-Cola in Kerala, etc, have been widely noted.

Besides, there is the issue of public hostility. Tata’s problems with the Nano have not escaped the notice of potential investors. So the key is to have stable, consistent policy - in land acquisition, mining rights, environmental certification, etc. There also needs to be a less complicated and less corruption-prone system of clearances and permits.

The Knowledge@Wharton article quotes the NCAER in saying that the benefits of FDI include skill enhancements, technology inputs, job-creation, and spillover effects. It does caution that the market power of MNCs may result in their ability to extract large profits; left unsaid is the possibility that they may do predatory pricing to drive local competitors to ruin.

In summary, as NCAER concludes, the empirical data suggests that the positives outweigh the negatives. Judiciously pursued, FDI can indeed be useful.

Rajeev Srinivasan is  a  management consultant