Published: The Hindu Business Line, June 07, 2004,

By Nitya Nanda

Merely receiving more FDI is no panacea for developing countries’ problems. The challenge before India is to get quality FDI that fosters development. As it is, getting FDI is quite difficult, but making it development-friendly is even more so.

WITH the new government at the Centre assuming office with the support of the Left parties, foreign direct investment (FDI) has become a topic of debate.

The Left has aired strong views on FDI, but this seems more a rhetoric; what about Left ruled West Bengal’s eagerness to attract FDI? Indeed, the country’s FDI policy has more or less been driven by ideological rather than practical considerations.

For about a decade since Independence, the country had an open attitude towards FDI. However, the Second Plan made a significant departure, emphasising on self-reliant economic development and a restrictive approach vis-à-vis FDI, to protect the domestic base of created assets.

The underlying philosophy was that transnational corporations (TNCs) which bring in FDI cannot be relied upon to the extent of allowing them to play a major role in the country’s development; the East India Company syndrome seemed to haunt the policymakers.

Further, in 1973, the Foreign Exchange Regulation Act (FERA) came into force, which limited the equity of foreign companies in Indian companies to 40 per cent. And in the late 1970s, some foreign companies were asked to leave the country.

However, there was a policy reversal in the 1980s. Industrial and trade policy liberalisation was accompanied by an increasingly receptive attitude to FDI and foreign licensing collaborations.

To modernise industry, a greater role to multinational enterprises was sought to be given. Exceptions from the general ceiling of 40 per cent on foreign equity were allowed on the merits of individual investment proposals.

Riding the wave of reforms, full-scale liberalisation measures were initiated in the 1990s, to integrate the Indian economy with the global one.

The Reserve Bank of India was allowed to give automatic approval for priority industries. Foreign investors were also given assurance of free remittances of profits and dividends, fair compensation in the event of acquisition, and a level-playing field. These changes in FDI policy were complemented by bilateral investment treaties (BITs) and double taxation treaties (DTTs), many of which were signed by India recently.

But can one expect consistency in India’s FDI policy? If the earlier policy was one of excessive fear, the new one dreams of seeing FDI make a major contribution to the country’s development; barring the Left, the general perception is on these line.

When the economic reforms programme was launched, it was well-recognised that the lack of infrastructure, such as roads and power, was a serious impediment to development.

However, there was confidence that FDI would flow in and address the problem. As a natural corollary, the state, which was more or less the only investor in these sectors, stopped further investment.

Foreign investments did flow in but not to the extent expected. In 2001, FDI as a percentage of GDP was 4.7, one of the lowest in the world.

Moreover, whatever FDI that came in more or less bypassed the preferred sectors — roads and power. After about a decade, it was realised that the state could not withdraw from these crucial sectors.

For example, in the ambitious highway development project, 95 per cent of the funding comes from the state. But a crucial decade was lost, delaying thereby the development process.

But the think-tanks soon thought FDI did not flow in because of bad roads and the poor power situation. But was not FDI basically invited to improve the road and power sectors? A Steering Group at the Planning Commission was constituted to study the FDI regulatory regime and suggest policy measures for increasing FDI flows. The crux of the Group’s recommendations was, liberalise further.

TNCs’ decision to locate in a country is based on the tax structure, special programmes and schemes, the competition regime, entry and establishment requirements, investment protection, technology transfer, natural resources and skill levels, incentives and institutional mechanism.

However, determining FDI flow is a complex process. For example, while India may seem more attractive than China on most of these counts, it attracts less than one-tenth the FDI into the latter.

Nevertheless, the Steering Group thought that the country needed to liberalise further. It went to the extent of diluting the Prevention of Food Adulteration Act and the Food Product Order, which are already quite weak and not rigorously enforced.

What one forgets is that China receives huge FDI not because it allows unrestricted entry but because its approval process is fast and efficient. Project status, be it a `yes’ or `no’, is known within a couple of months. In India, on the other hand, even after two years one may still be unaware of the status.

And by the time approval comes through, the situation may have changed, prompting the investor to park the money elsewhere. This is the reason for the huge gap between approved FDI and the actual flow.

This lethargic decision-making process affects not only foreign investors but domestic investors as well. This needs to change for India to realise its actual growth potential.

However, the enthusiasm shown by most developing countries today in attracting FDI is more because of ideological factors rather than ground-level changes.

The propaganda of the World Bank and the IMF, among others, on the importance of FDI has been such that it is now believed that a country cannot develop without FDI. But the fact is, receiving more FDI is no panacea for developing countries.

China has maintained high GDP growth along with huge FDI flows. However, it started receiving FDI only after it got into a high growth path.

Hence, large FDI flow is the effect of high growth and not the other way round. Even today, China’s growth is largely driven by domestic capital formation, and FDI as a proportion of total investment is barely 10 per cent.

Very often there is talk about the South-East Asian miracle. Again, these countries have achieved high growth by mainly depending on their domestic capital accumulation rather than FDI.

The experience of Brazil and Argentina, the two Latin American nations that attracted huge FDI throughout the 1990s, is even more telling. Argentina is in a deep crisis and the Brazilian economy has remained stagnant for long. It is, therefore, quite clear that huge FDI flows have not been of any real value to these countries.

The challenge before India is not to attract more FDI but to get quality FDI that fosters development. As it is, getting FDI is quite a challenge, and making it development-friendly is even more difficult. But there is no need to go out of the way to attract FDI. India must gain confidence in itself, that growth can be achieved with or without FDI.