External direct financing isn’t proving all that beneficial, as Indian policymakers now realize. Not on par with exports at least. What were pure FDI (foreign direct investment) receipts in the first period have strings attached in subsequent periods as associated outflows mount and perversely pressurize both the fiscal and current account deficits. This exposes a narrow policy focus in liberalizing the financial side of the balance of payments without sufficient attention to countervailing repayments support from exports and other investment incomes. Ironically, the desperation for foreign capital is forcing policies even more in this direction.
Anxious over the current account balance, the Reserve Bank of India is reported to have suggested fiscal measures for boosting returns from foreign investments by resident businesses. This includes tax exemptions for dividend payouts, among others. The central bank should been alert earlier. The first warning note came in 2010-11, when the deficit on investment income—a component of the current account representing interest receipts and payments on financial assets and liabilities along with dividend on corporate stocks—suddenly expanded 2.6 times over 2009-10s. Receipts fell 34%, while repayments (outflows) rose 26%. From then on, average receipts are 40% lower than the preceding three-year average (2008-10) while repayments are 26% higher in corresponding terms. In the current year, income earned from investments abroad is just one-third of that earned by foreign firms in India ($15.5 billion).
Flows create stocks; so the picture of external accounts is incomplete without a look at the international investment position, which summarizes a country’s stock of external financial assets and liabilities at a point in time. Here, FDI-related liabilities (royalties, etc.,) lead the deterioration in India’s external financial wealth, with a 45% jump year-on-year at end-March 2010 followed by a 16% rise the next year. Over March 2009 to March 2012, liabilities due on FDI increased by 75%; as percent of GDP, they average 12.5% since March 2010, a three point increase over March 2008 shares. Multinational firms are steadily hiking royalties. According to Bloomberg (based on data from Institutional Investor Advisory Services), royalty fees by local units of two dozen foreign firms more than doubled in the past four years.
These are long-term, structural trends, contributing towards the current account imbalance and eroding the external financial wealth; especially as export earnings and other income is inadequate to offset the exodus. The trouble doesn’t end here. Tax caps on royalties (10%) under double tax avoidance treaties impacts the fiscal deficit, too; efforts to increase the levy to 25% in the 2013-14 budget and reduce the internal financing gap somewhat are frustrated by such bilateral agreements. Ironically, an intended review of these treaties to address this problem is now postponed in the desperation for foreign investment.
A holistic policy assessment ought to compare outcomes with past decisions. For example, would tax exemptions on export-promoting SEZs, fiercely resisted by the finance ministry, have delivered better macroeconomic outcomes or proven less costlier than tax concessions to foreign investments in non-exporting sectors? Many other questions can be asked. What is critical is that economic policies should focus hard upon exports even as liberalizing inward-outward investments remains a desired policy objective.
Renu Kohli is a New Delhi-based macroeconomist; she is currently Lead Economist, DEA-ICRIER G20 Research Programme and a former staff member of the International Monetary Fund and Reserve Bank of India.