Foreign direct investment (FDI) limits were eased in mid-2016 to allow foreign firms to own 49% in a venture without government permission, and a higher stake was allowed if the venture had access to state-of-the-art technology.
While it is flattering the world’s top defence players are attending the DefExpo, India’s defence sector hasn’t really attracted any meaningful investments. Foreign direct investment (FDI) limits were eased in mid-2016 to allow foreign firms to own 49% in a venture without government permission, and a higher stake was allowed if the venture had access to state-of-the-art technology. However, most of the partnerships announced are in the nature of technical collaborations; the poor FDI, of course, is also related to poor progress in the government placing orders. While flows into the industrial and manufacturing space have picked up pace in the last five years, nearly doubling to $17 billion in the five years to 2016-17, this remains smaller than the amount coming into the services sector. Even Saudi Aramco’s investment in a refinery would see about $7-8 billion coming in over four or five years. Indeed, if FDI flows into India have roughly doubled over the past decade, to $42 billion in FY17, it’s the services sector that has attracted the big chunks.
If India is to really scale up production and jobs-creation, it is necessary to grow the manufacturing sector. So far, the insufficient infrastructure, rigid labour laws and an unstable regulatory environment seem to have hampered flows into industry; a fair bit of the FDI has come into companies that are well-established and where regulation is relatively less important such as FMCG multinationals. But more foreign capital in defence, for example, can help use the technical expertise of engineers, while manufacturing facilities could absorb both skilled and unskilled workers. Indeed, it is unfortunate that sectors such as pharmaceuticals aren’t attracting the attention of global players and cashing in on the large pool of scientists and science graduates. The sector pulled in less than $1 billion each in FY16 and FY17, lower than the $1.5 billion in FY15. The auto sector too saw just $1.6 billion in FY17 compared with $2.6 billion in FY16 although India has relatively cheap labour and also a big home market. Given how, for various reasons, capital available with local industrialists is limited, it is critical India attracts more FDI in manufacturing.
The other reason why FDI is important is because it boosts the balance of payments. Of the total net capital flows of $240 billion, estimated in the three years to FY18, close to 55% has been accounted for by FDI, with the remainder coming in via portfolio equity and debt flows. This is a big reversal over the trend in the previous 10 years when FDI accounted for less than 30% of the inflows. However, in the December quarter, FDI flows weakened though economists believe it could be a blip. Nevertheless, with the price of crude oil now nudging $70, there is a real chance the basic BoP—the current account deficit minus the FDI—will turn negative in FY19.