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Business News/ Opinion / One swallow doesn’t a summer make
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One swallow doesn’t a summer make

India is an attractive FDI destination now but the government needs to do more to sustain big inflows

Photo: MintPremium
Photo: Mint

There is an old adage that bull markets climb a wall of worry but having climbed one wall, it is the nature of markets to worry about the next one. It is sometimes instructive to think back about the walls that were encountered in the past and how they were scaled.

A formidable one that the Indian markets faced in recent times was after what is now called the taper tantrum in 2013. With high current account and fiscal deficits, India was clubbed with four other such emerging markets into the infamous Fragile Five. Two years later, it is now the consensus opinion that India is out of that club and better prepared to deal with the situation as and when the US Federal Reserve decides to raise interest rates.

Indeed, India’s current account deficit (CAD) has shrunk from 4.7% of gross domestic product (GDP) in fiscal 2013 to 1.4% last year, by far the best adjustment among the Fragile Five countries. What is even more heartening is the fact that India’s dependence on volatile portfolio flows to fund its CAD has reduced. Net foreign direct investments (FDI) exceeded CAD for the first time since fiscal 2008, signifying that the deficit is now funded with stickier capital (see chart). The improvement in FDI is noteworthy with the United Nations Conference on Trade and Development estimating that India jumped six places to ninth position in 2014 in the FDI league table.

Apart from the increase in quantum of FDI, both absolute and as a share of GDP, there are a few other interesting trends worth noting.

One, the investments have been granular and well spread across many sectors unlike some of the earlier years when a few deals accounted for bulk of the inflows, raising questions over sustainability of flows.

Two, net outward FDI (i.e., Indian investments overseas) has reduced to a trickle. From a peak of $19.4 billion in fiscal 2009, this has slowed to a mere $1.8 billion in fiscal 2015. It is difficult to attribute this to a single factor but overseas misadventures of large Indian firms in the past few years still seem to be weighing on the private sector mind. This is important because India has had higher absolute gross inward FDI in the past, but the net number was lower due to a large quantum of outward flow.

Data for sectoral break-up of FDI is available only for the equity component of gross inward flow. Of the $44.3 billion of gross inward FDI in fiscal 2015, equity investments accounted for about $32 billion.

The third trend is that the share of infrastructure and real estate within this had fallen to a low of 11.7% in fiscal 2013 but retraced towards decadal average of 23.6% in fiscal 2015. We think this will be an enduring trend with Indian infrastructure assets such as the Dedicated Freight Corridor etc. getting funded through FDI. While this may not be able to fully replace bank funding for infrastructure, it will ease some of the logjam faced in the sector today due to over-leveraged asset developers and capital-strapped public sector banks.

Fourth and possibly the most important trend is the emergence of a new sector from close to nowhere a few years ago—FDI in e-commerce and Internet space. Again aggregate data is hard to come by and sectorally, this gets diffused over many heads but a bottom-up analysis of deal sizes in excess of $5 million done last year, adds up to almost $5 billion. Thus, almost 20% of the gross inward equity inflows were accounted by this new source. This trend shows no signs of ebbing in the current year with an ever increasing crowd of global tech companies and venture capitalists not wanting to miss the action in the Indian Internet sector. Also, as Farhad Manjoo recently put it in The New York Times, unlike the dotcom boom of the 1990s when the holy grail for a technology company was to go public with an initial public offering (IPO), this time around all efforts are being made to not file for an IPO and remain private. This means that tech companies will continue to play in the unlisted space, making stickier FDI the only route for foreign participation.

While we are moving towards claiming our rightful share in global FDI, one has to be cognizant of the fact that a lot still needs to be done to make India an attractive destination for sticky foreign capital. On the World Bank ranking of Ease of Doing Business, India slipped two places to a lowly 142 among 189 countries. Today, Foxconn Technologies is grabbing the headlines for planning to set up an iPhone manufacturing facility in India but the South Korean steel maker POSCO, whose $12 billion steel plant was India’s single largest FDI proposal, managed only a small obituary in the back pages. The feverish debate around investments by Wal-Mart and Ikea in India’s retail space seems to have all but died down and that’s not a good sign. The TINA (There is No Alternative) mindset that foreigners will invest in India owing to its large market potential, regardless of red tape and regulatory hurdles, breeds complacency. It may be too early to celebrate the improving trends in FDI and naïve to assume that India has already become the capital destination of choice.

Swanand Kelkar and Amay Hattangadi work with Morgan Stanley Investment Management. These are their personal views.

Comments are welcome at theirview@livemint.com

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Published: 27 Jul 2015, 12:16 AM IST
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