Editorial 2: A complex turn in India’s FDI story

Context

The withdrawal of funds by foreign firms after short-term profits, coupled with Indian firms investing abroad, exposes systemic gaps that need urgent attention.

Introduction

Since the post-1991 economic reforms, foreign direct investment (FDI) has been a key driver of India’s economic growth. It has significantly modernized the country’s industrial base, spurred technological innovation, and strengthened ties with global markets. Sectors like e-commerce and computer hardware and software have particularly benefited from substantial FDI inflows, transforming their landscapes. However, recent trends indicate a more nuanced picture, with investment levels declining. While India continues to attract foreign capital, much of it is focused on short-term profits rather than long-term industrial development. Simultaneously, the rise of Indian firms investing abroad raises concerns about the health of domestic investment conditions.

Divergence between inflows and outflows

• Gross FDI inflows reached $81 billion in FY 2024-25, up 13.7% from the previous year; between 2011–2021, inflows rose from $46.6 billion to $84.8 billion, highlighting India’s investor appeal.
• After peaking in FY 2021-22, inflows fell to $71 billion in FY 2023-24 before a slight recovery; post-pandemic, gross inflows grew at 0.3% annually, while foreign disinvestments/repatriations surged at 18.9% annually.
• During this period, India saw $308.5 billion in gross FDI inflows, but foreign investors withdrew $153.9 billion, causing net FDI inflows to decline sharply; after adjusting for outward FDI by Indian firms, net retained capital fell to just $0.4 billion.
• Disinvestments rose 51% to $44.4 billion in FY 2023-24 and further to $51.4 billion in FY 2024-25, now over 63% of total FDI activity, indicating a shift from long-term strategic investments to short-term profit-seeking, often via tax arbitrage or treaty-based routing.
• The manufacturing sector, once a primary FDI target, saw its share drop to 12% due to massive outflows.
• The decline in net inflows and surge in outward FDI by Indian firms (from $13 billion in FY 2011-12 to $29.2 billion in FY 2024-25) reflects regulatory inefficiencies, infrastructure gaps, and unpredictable policies, limiting job creation, innovation, and industrial growth.
• Despite government reforms and improved rankings, regulatory opacity, legal unpredictability, and inconsistent governance continue to discourage investors.
• The parallel trend of foreign firms withdrawing funds and Indian firms investing abroad highlights systemic lacunae that must be addressed to sustain India’s long-term economic development.

Trends and Challenges in FDI

• Gross FDI inflows may appear promising but hide underlying issues: rising disinvestments, shifting investment patterns, and growing capital outflows signal eroding investor confidence.
• Short-term capital inflows dominate, lacking the potential to support long-term growth.
• Sectoral trends: FDI increasingly flows into services and rent-seeking sectors (financial services, energy distribution, hospitality) rather than manufacturing, infrastructure, or advanced technology, limiting multiplier effects and economic resilience.
• Sources of FDI: Financial centres like Singapore and Mauritius often channel investment for tax strategies, while traditional industrial investors (e.g., US, Germany, UK) are reducing involvement.
• Outward FDI: Around half of India’s FDI outflows target developed economies, attracted by favorable tax regimes, market stability, and strategic resources.

Policy Implications and Recommendations

• India must prioritize reforms that reward long-term investment commitments to build a resilient investment ecosystem.
• Key measures include simplifying regulations, ensuring policy consistency, investing in infrastructure, and enhancing education and skill-building to meet evolving industry needs.
• Macroeconomic impact: Declining net FDI inflows affect capital availability, balance of payments, and currency stability, reducing monetary policy flexibility.
• India needs to proactively attract and retain investment aligned with developmental and technological goals to sustain long-term economic growth in a global context.
• The Reserve Bank of India emphasizes that while rising outflows mirror trends in other emerging economies, they pose risks requiring careful management.

What needs to be done

• To become a global investment hub, India must go beyond headline FDI figures.
• Focus should be on the quality, durability, and strategic alignment of capital inflows.
• Overemphasis on gross FDI figures, without considering their source or impact, can mask deeper economic vulnerabilities.
• India requires committed capital investment that builds domestic capability and aligns with national priorities.
• Key enablers include:
  • Streamlined regulations
  • Infrastructure upgrades
  • Policy stability
  • Renewed trust in institutions
• Investing in human capital is essential to attract high-value sectors such as:
  • Advanced manufacturing
  • Clean energy
  • Technology
• India is at a critical juncture in navigating its FDI strategy.

Conclusion

India’s FDI landscape shows promise in gross inflows but masks structural vulnerabilities, rising disinvestments, and short-term profit-seeking. To secure sustainable growth, the country must focus on quality, long-term investments, strengthen regulations, upgrade infrastructure, and invest in human capital. Only by aligning FDI with national priorities and technological goals can India emerge as a resilient global investment hub.