Challenges of FDI Policy in India

Priya Arora :

Indian economy has experienced high rates of growth in the post reforms period which is accompanied by increased employment, improvement in the infrastructure of the country, reduced poverty and raised the standard of living of people.

From 1991 to 2011 the total population of India has increased from 880 million to over 1.21 billion. In which the proportion of people between the age group of 0-15 formed 37.76% in 1991 and 28.48% in 2011 of the total population and proportion of people in the working class was around 55.58% and 63.38% of the total population. Another interesting fact is that India produces more than 3.5 million graduates and 0.85 million post graduates every year. Despite attaining higher education only 30% of the graduates get a job.

Studies show that India needs to create 16 million new jobs every year, i.e., over 13,00,000 jobs each month- a herculean task by any standards. 50 percent of India’s population is below the age of 25 and more than 65 percent is estimated to be below the age of 35. It is expected that, in 2020, the average age of an Indian will be 29 years, compared to 37 for China and 48 for Japan. While it is easier to absorb new entrants into jobs of lower productivity, it will be more challenging, but critical, for India’s future success to meet people’s rapidly-rising aspirations by creating jobs of higher quality.

This is the crux of India’s employment challenge. Continued high growth, though very desirable, cannot necessarily be relied upon to meet India’s enormous employment challenges. Clearly there is a need to match such high demand of jobs by creating an adequate supply, which can be generated if there is an increase in foreign direct investment (FDI) from other countries. It is high time that India should welcome FDI in order to save the country from many problems looming over it.

According to Ernst and Young’s 2010 European Attractiveness Survey, India is ranked as the 4th most attractive FDI destination in 2010. However, it is ranked the second most attractive destination following China in the next three years. One of the best returns on investment are offered by the Indian economy which makes it an attractive destination for the domestic as well as foreign investors. However there are certain issues that need to be looked upon by the government of India in order to efficiently attract more FDI from other countries. Some of the problems which are hindering the flow of FDI in the country are:

It is a well-known fact that small-scale industries in India have always received significant preferential treatment. The government of India has also put a ceiling of 25% on FDI on small-scale units. However in China the floor level of investment in the small-scale industries called TVEs (Town and Village enterprises) is 25% and it is allowed up to 100%.There is a great deal to learn from China in this area, FDI in TVEs has led tremendous technological spill overs and innovation of new products. Also, 65% of Chinese exports come from these TVEs. There is a lot of untapped potential in India’s small scale industries, it may sound small but can actually play a very important role in growth of the country.

Another problem is the weak legal enforcement that erodes the competitive edge of India for FDI. A stricter implementation of Intellectual Property Rights (IPR) boosts the investors’ confidence and lead to innovation. As per the World Bank Doing Business indicators in 2013, India ranks 134 out of 189 countries in term of enforcing a contract.

The relationship between IPR protection and FDI is quite complex. A weak IPR regime increases the probability of imitation, which makes a host country a less attractive location for foreign investors. However a strong protection may shift the preference of multinational corporations from FDI towards licensing. At the same time, a weak IPR system increases the benefits of internalization; since it is associated with a greater risk of the licensee’s breaching the contract and acting in direct competition with the seller. An inadequate IPR regime, therefore, deters FDI and encourages exporting.

Certainly there are specific short-term costs associated with intellectual property rights for the developing countries, like higher prices for the technology and protected products. Given this, the case for stronger intellectual property rights in these countries must rest on long-term benefits like larger technology or foreign direct investment inflows and stronger stimuli to local innovation. Researches’ indicate that an adequate level of protection for IPR increase the level of FDI in the country.

Another problem faced by most of the developing countries is of implementing an appropriate tax structure. In today’s global environment there is immense Tax competition for FDI by various countries. Investors from other countries compare tax burdens in different locations, as do policy makers, with comparisons typically made across countries that are similar in terms of location and market size. High corporate taxes in India (30% for domestic company and 40% for foreign company excluding surcharge and education cess) can affect the flow of foreign direct investment significantly. However the corporate tax in other developing countries is much lower than that in India. Hong Kong’s corporate tax at 16.5%, Singapore’s 17% and Malaysia’s 25%, these countries, with their lower corporate tax rates, can provide stiff competition to India for attracting FDI. Studies examining cross-border flows suggest that on average, FDI decreases by 3.7% following a 1 percentage point increase in the tax rate on FDI. The focus of Indian government should be on setting up an efficient and fair tax system, so that it can raise the essential revenue and does not rely on borrowing.

India can learn from some of the developed country’s experience. Let’s take Europe’s example. Europe’s objective to protect its products is fulfilled by following certain measures like Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). The EU negotiates IPR provisions in its bilateral trade agreements and works closely at a technical level with its trading partners on IPR issues. The EU was also involved in the development of the Anti-Counterfeiting Trade Agreement. The state government, the central government and the society, should also make a coordinated effort to realize the benefits of an effective IPR system.

According to a study of emerging economies that analysed which country had the most monetary and fiscal firepower. It studied 27 countries and used five indicators: inflation, excess credit (the growth in bank lending minus the growth in nominal GDP), real interest rates, currency movements and current account balances. It showed that China, Indonesia and Saudi Arabia have the greatest capacity. India occupies the bottom of the scale (27th) along with Egypt. The study showed that India does not have the fiscal power to be able to balance the economy and engage in massive fiscal programmes.

This is evident of the fact that Indian economy needs FDI which can solve most of these problems. All these facts and figures, support the flow of FDI in India.

(The author is a former student of the Madras School of Economics).


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