The total FDI (Foreign Direct Investment) inflow in India was $35.73 billion from April to August, the highest ever for the first five months of a financial year.
This huge inflow of foreign investments is seen as an achievement of the current government since the investors all over the world are hesitant in making any major investments during these uncertain times. The Ministry of Commerce and Industry said it became possible because of measures taken by the government including reforms on the fronts of FDI policy, ease of doing business and investment facilitation amongst others.
But why is this a matter of celebration? Why are foreign investments so important for a country?
Lesson from the past
India has learned from the past that foreign investments can be a game changer when it comes to economic growth. Till 1991, the country had never seen GDP growth crossing 6% even after years of planning by the best of the economists. In 1991, due to several compulsions, the then government had to liberalize the economy. In the period of 1992-97, the country witnessed an average growth rate of 6.8%.
Economic development of a country
Developing nations face the issue of perpetual lack of funds and ever increasing needs related to social welfare and economic development. Foreign investments are crucial for fulfilling this very need, they provide the necessary funds required by a country.
- Increases employment- This is one of the biggest reasons why a developing nation looks to attract FDI. Increased FDI boosts the manufacturing as well as the services sector which in turn creates jobs, and helps reduce unemployment among the educated youth – as well as skilled and unskilled labor – in the country.
- Human resource development- With funds, foreign investors and companies also bring their knowledge and expertise in their respective fields. They impart these to their employees in the form skills which raises the quality of human resources of the country.
- Development of Backward areas- FDI enables the transformation of backward areas in a country into industrial centers. For instance, The Hyundai unit at Sriperumbudur, Tamil Nadu helped the small town develop economically.
- Exchange rate stability- Constant inflow of FDI in a country increases its forex reserves. Comfortable forex reserves ensure stable exchange rate and give more leg room to the Central bank of the country to change the currency rate as per need.
- Increases competence of the businesses of the country- Introduction of foreign players breaks existing monopolies and ensures that erstwhile protected domestic businesses ramp up their competence to be able to survive the new competition. This raises the overall competence and innovation levels in the country.
- Exchange of Technology- The domestic businesses benefit from foreign collaborations as they bring technological knowhow and managerial expertise which can multiply profits accrued by a business.
Win-win situation for all
It’s not just the recipient of foreign investments which benefits from such investments. The investors also get a lot in return. For instance, it helps in diversifying the investor’s portfolio.
The investors also tend to invest in a developing nation due to rapid economic growth of such countries (India and China are the fastest growing countries, whereas most of the developed countries have reached a point where the growth potential has considerably reduced). Investment in a developing country gives investors huge return on their investments as interest rate is mostly much higher there.
Downsides
But just like everything else, foreign investments are not without downsides.
In the 1997 Asian Financial crisis, several south east Asian countries like Malaysia and Singapore saw mass withdrawal of funds by foreign investors. This led to huge currency devaluation, stock market decline, reduced import revenues and government upheavals.
To avoid such situations, countries try to incentivize longer and more stable investments. In India, an investment to be classified as FDI, the investor needs to acquire a minimum 10% of the voting power in an organization. If the investor owns less than 10 per cent, the International Monetary Fund (IMF) defines it as part of his or her stock portfolio (FPI or, Foreign Portfolio Investment). To incentivize more stable investments, FDI investors are provided way more benefits than FPI ones.
Along with that, there’s an added risk of foreign competition destroying domestic businesses. Even though extra funds and competition are always welcome in a country, sometimes the competition also puts domestic enterprises at risk. Domestic businesses usually lack knowledge, skills and competence to compete with technologically advanced foreign businesses. Due to this imbalance, a country tries to protect its enterprises by providing subsidies and other preferential treatment.
Scope for more investments
India is considered to be an attractive market destination by the foreign investors due it to its rapid economic growth, liberalized FDI norms, ease of doing business, preferential tariffs and labor surplus.
Now that global economy is somewhat isolating China, investors are looking for an attractive market as an alternative. India can utilize this opportunity and project itself as that alternative.
Komal is an English literature student with a keen interest in economic developments and politics amongst others. She is a part of Research & Content team at HrNxt.com