However, the experience so far indicates that mere liberalisation of FDI rules may not really help. Despite significant reforms in the FDI regime since 1990, Indias share in FDI stood at only 1% in 2012, as per UNCTAD data. While the country ranked third in GDP (purchasing power parity), its position was 15th in terms of FDI inflows (14 in 2011). In contrast, China, which has widespread formal restrictions on inward FDI, has been the top recipient of FDI inflows. It has FDI restrictions in a long list of sectors deemed critical to its economy. Beijing regularly publishes lists of sectors where foreign investment is either encouraged, restricted or prohibited. In addition to outright limitations on foreign equity ownership, there are extensive investment conditions on technology transfer, domestic procurement and joint ventures, and limitations on the employment of foreigners as key personnel. But FDI flows remain extremely high. Between 2001 and 2012, the average annual inward FDI flow into China, as a portion of its GDP, was 11.4 %, whereas in India, it was just 4%.
Lower entry barriers are unlikely to push up Indias FDI inflows significantly. Rather, good quality infrastructure, low administrative costs of setting up and running businesses, and predictable macro-economic policy could be important factors. India, in the World Banks Ease of Doing Business list for 2013, ranked 132 out of 185 countries. The cost of doing business is so high that even local entrepreneurs are shifting their manufacturing bases to overseas. It is evident from the fact that the outward investment has been growing faster than FDI inflows.
According to UNCTAD data, between 2000 and 2012, inward FDI stock increased 14 times from $16 billion to $226 billion while outward investment multiplied 68 times from a mere $1.7 billion to over $118 billion. The accompanying chart shows aggregate FDI inflows (including equity, reinvested earnings and loans) and outflows (inclusive of equity, loans and guarantees) over the past decade, as per RBI data. Evidently, in some years, the amount of overseas direct investment by Indian companies even exceeded FDI inflows into the country. Domestic industry seems to simply opt for foreign locations to avoid rigidities in the policy regime here. This is striking for a developing country such as India and calls for prompt action to address the numerous problems that make India rank so low on the World Banks ease-of-doing-business surveys. While this requires a long-term strategy, there are indeed low-hanging fruits that can be plucked.
One immediate step would be to revive SEZs. It must be understood that SEZs are not the trade-based enclaves that are the second-best solution. They need to be viewed as geographically concentrated agglomerations of internationally competitive enterprises that offer favourable business environment including efficient infrastructure and quality services, few regulatory restrictions and a minimum of red tape.
Since 1991, a large number of industrial parks/zones offering attractive incentives, grants and concessions have emerged in India. These include industrial parks, growth centres and export promotion industrial parks (set up by the Department of Industrial Policy and Promotion); food and mega food parks (by the food ministry); integrated textile parks (textile ministry); bio-parks (Department of Biotechnology); electronics hardware parks (Department of Electronics); and special economic zones (commerce ministry). None of them, except SEZs, could trigger a significant flow of investment and employment creation in the economy. SEZs have attracted investment worth R2,88,477 crore and created almost 11 lakh direct jobs. Major policy reversals and global slowdown in recent years have, however, dealt a heavy blow to them. Of the 389 notified zones, only 185 are exporting. Considering the fact that even the operational zones are not fully occupied, there is a large chunk of industrial land available there. A major corrective measure would be to restore investor confidence in them by:
* Reinstating the original benefits offered to them,
* Invoking section 51 of the SEZ Act which allows the provisions of the Act to override the provisions of any other Act and,
* Ensuring that the ministry of commerce, which fathers the scheme, alone can propose changes in the Act/rules.
Another important step will be to integrate them with the rest of the economy through backward and forward linkages to spur investment and employment in the rest of the country. The present policy completely discourages forward linkages by allowing domestic sales only after paying all tariffs and in some states even VAT. Duty-free imports affect backward linkages (the use of local inputs) also. Many successful countries including China, Korea and the US have adopted an innovative policy of allowing 100% domestic sales from SEZs after paying duty only on the value of the foreign non-duty-paid content. If there is no imported component in the product, domestic sales are completely duty-free. This strengthens not only forward but also backward linkages. China permits domestic sales from SEZs also if the SEZ product is manufactured using new and sophisticated technology (as defined by the law). There is thus a compelling need for strategising SEZs. They can be instrumental in attracting both local and foreign investment, and stimulating and updating economic activities in the domestic economy through both backward and forward linkages.
Co-authored with Rajlaxmi Mohanty
Aggarwal is director, Wadhwani Foundation Policy Research Centre and Mohanty, a research associate