Economics Commentary on Foreign Capital Shuns India

Foreign Capital Shuns India

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Is India looking at a capital crunch ahead?

The way India's markets have been battered in the past month is worrying enough, but a more alarming trend has been running for nearly a year now: foreigners are wary of committing longterm capital to the country.

Approved foreign direct investment—mainly in mines and factories—fell 27% between April and November from a year earlier, according to the latest data available. FDI had been falling even as a record $29 billion flowed into the country's stock markets during 2010. This makes India the only major nation in Asia to witness a decline in FDI last year, according to the United Nations Conference on Trade And Development.

In contrast, annual FDI nearly doubled in the years just before the global financial crisis, a faster pace than the increases in foreign purchases of Indian stocks and bonds. And even when the markets began to collapse in 2008, FDI grew at a healthy 72%.

This recent aversion to longterm commitment could pose a bigger problem than stock-market volatility. India already runs a high current-account deficit (expected around 3.5% of the gross domestic product for the fiscal year that ends in March), and high global commodity prices will further strain its balance of payments. A large part of this deficit is financed by shortterm portfolio inflows. That money can easily turn to outflows, as has been happening through January. And a wide deficit makes the currency weaker, in turn further discouraging investors.

More broadly, for India to sustain its economic growth, it must develop its transportation infrastructure, as well as address its structural inflation problem by increasing farm productivity and distribution. FDI is critical to both these goals and New Delhi is counting on it; it expects nearly 70% of the $1.5 trillion planned investment in infrastructure projects between 2007 and 2017 to come from private companies or via joint ventures between the public and private sectors.

But it's New Delhi that has helped keep investors away. Consider this: A $12 billion project by South Korea's steelmaker Posco, the largest-ever foreign ...

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But it's New Delhi that has helped keep investors away. Consider this: A $12 billion project by South Korea's steelmaker Posco, the largest-ever foreign direct investment in India, was only recently approved after five years of government delay. The clearance comes with several riders, like mandating Posco to spend 2% of the steel plant's net profit on social welfare.

To retain foreign capital, the government needs to speed up execution on investments in everything from roads to power plants. New Delhi must deliver on the promised crucial reforms, such as opening the insurance and retail industries to overseas investors. More importantly, it should convince investors it's dealing strictly with corruption and a sluggish bureaucracy.

This deficit of trust needs urgent mending.

Commentary Number 2

Foreign direct investment (FDI) refers to long-term investment by firms based in one country in productive activities in another country. Firms that undertake foreign direct investment are also known as multinational corporation (MNC) or transnational corporation (TNC), since they operate in more than one country. Foreign direct investment may refer to either investment in control of acquired asset of local companies or investment in new facilities. UN Conference on Trade and Development had done a survey showing the global foreign direct investment inflows in 2005 based on the geographic and economic differences. The result shows that developing country inflows possessed over 36% share of global inflows.

From the data we can know that, multinational corporations tend to involve themselves into developing countries, especifically the ones with healthy yet stable political and economic environment which ensure their freedom to pursue their economic interests with the minimum government interference, meanwhile boost their profitability. In this case, India is a great match for multinational corporations to engage foreign direct investment at first sight. Its economic growth rates are stable in recent years, manufactured goods such as iron and steel are sold in a relatively cheap price, which benefit both the MNC and Indian’s industries. However, it’s existing problems in regularity systems and balance of payments are slowly deteriorating multinational corporations’ appetites to engage further investments, hence make the country harder to sustain its economic growth.

As the article has mentioned: “A $12 billion project by South Korean steelmaker Posco was only recently approvoed after five years of government delay.” Certainly there are existing internal problems such as ‘corruption’ and ‘sluggish bureaucracy’, which are evidently not what foreign companies like Posco are looking for. The qualities that intrigue multinational corporations to invest in India are the economic prospects of India, which offer them possibilities to maximize their profits in the shortest time, but if a hot project like the one in Posco postpone for such a long time, it certainly infers that Posco in not satisfied with the outcome. Furthermore, Indian government also requires the South Korean firm ‘to spend 2% of the steel plant’s net profit on social welfare’, that obviously discourages firms like Posco from maintaining further economic activities in India, since they are here because they feel the right to pursue their economic interest with the least external interferances. Certainly, the case of Posco is not an unique incident, it also reflects the general picture of the overall foreign investing activities in India stem from the government intervention, or let’s say, their inefficiency.

However, if we put ourselves into the government’s shoes, we might find arguments for the government. Since India is a developing country with a very high annual economic growth rate, the government does not want to hurt its domestic firms by eliminating competition and importing foreign products as their alternative for domestic goods. The government might also concern that its low labour costs will not benefit its local workers since most foreign firms might possibly fill them only in low-skill positions. To put it further, government might afraid that with the greater foreign capital injection from MNCs, the greater power that the MNCs will possess to influence government policies, and possibly leading the country to unfavorable development processes.

The arguments above seems very plausible, but in this case, India is also facing another problem, which is its unsophisticated infrastructure. This cannot make significant improvements without the help of foreign countries, or in this case, foreign firms. Poor infrastructure is perhaps the biggest impediment to growth for India, since the country has a rapid population growth, and many people are still suffering from accessing essential infrastructure, such as health care, sanitation, transportation, education etc. If foreign direct investment takes place in a way that it’s supposed to be, India can possibly make very great improvement in infrastructure, since foreign capital injection can lead to greater tax revenues and higher economic growth, which enable India to invest capital on local employment, local industry, local technical skills that are beneficial in improving the overall standard of living and the economic state of India.

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Data from UN Conference on Trade and Development, World Investment Report 2006: FDI from Developing and Transition Economies: Implications for Development (UNCTAD, 2006), adapted from Annex Table B1.