Sunday, February 24, 2013

18వ వర్ధంతి










































DEVELOPMENT WITHOUT F D I



I am most honoured and grateful to be asked to deliver the Eighteenth Rudraiah Chowdary Memorial Lecture. I did not have the privilege of knowing the distinguished educationist personally, but have heard highly of his missionary zeal and contribution to the development of education in Ramachandrapuram. This is a town I happened to live in for over a year and have very fond memories of. Two decades ago I studied two villages of this region operating from here and this formed the basis of my subsequent training in economics.

When, in 1991, India ushered in major macroeconomic reforms under the leadership of Prime Minister Narasimha Rao, many hopes were raised about foreign capital flows into India. Expectations were particularly high about foreign direct investment (FDI) in transforming the economy and placing it on a significantly elevated growth path. The optimism has been informed by the economic success stories of other Asian nations, notably China. What has been India’s experience with FDI? What are the prospects on this count, given the deepening global economic crisis today? How crucial, in fact, is FDI for India’s long-term development? I address these questions today mainly with a view to promoting public discourse on the issue. Major issues of public policy should form part of collective consciousness of all educated Indians and cannot be left to ‘experts’ alone. In the interest of consistency and perspective, I propose to approach the problem through raising a set of connected questions.

What is FDI?

Apart from foreign aid through bilateral agreements between governments or concessional loans from multilateral institutions (e.g. the World Bank and the IMF) and banking capital, private foreign capital flows take two major forms. The first refers to short term capital flows into Indian capital markets. These are purely financial investments in India held by foreign institutions such as pension and provident funds, hedge funds and so on in search of higher returns than are available elsewhere in the world. These are known as foreign institutional investments (FII). Such funds can be withdrawn from India anytime depending on investor perceptions of returns and safety of funds parked in India. FII capital can have no long term impact on real economic activity of production and employment in the Indian economy. In contrast, foreign direct investment (FDI) is long term capital aimed at creation of production facilities in India. Consider, for example, a Korean firm setting up facilities for production of cars in India. This would mean incomes and jobs for Indians.





What are the effects of FDI?

As long term investments in India, FDI supplements home investment financed by domestic savings, thus helping economic growth in the host economy. In addition, FDI is welcomed because of the possibility of transfer of new technologies into India which can then be diffused among domestic firms to their advantage. Finally, FDI is believed to improve the country’s export performance and therefore foreign exchange earnings.

What are the factors attracting FDI?

Studies have shown that two major factors serve to attract FDI into any country, including India: First, the rate of growth of the economy, and second, the level of foreign exchange reserves. The first ensures that the size of the market is increasing. This would increase the volume and rate of profits for foreign firms operating in India. The second factor would assure the foreign firms that repatriation of profits to their parent firms abroad presents no difficulty. Further, adequate foreign exchange resources means that imports of critical items are not affected.

What are the factors discouraging FDI?

Again, studies conducted by the Reserve Bank of India point to two negative factors discouraging FDI into India. A high rate of inflation and high levels of public debt seem to work against FDI flows. Inflation implies reduced real rate of return on investment, devaluation of local currency and a high degree of uncertainty of production decisions by foreign firms. High levels of public debt (which includes domestic as well as foreign debt) would reflect poorly on the financial solvency of the government and the economy. This would certainly unnerve foreign firms.

What has been India’s experience with FDI?

The simple conceptual framework we have outlined above helps us appreciate India’s actual experience with FDI. It is important to look at the broad trend of FDI into India. Notable increases in FDI flows into India occurred only after 1992, a period signifying a liberal foreign investment environment. In earlier decades, India adopted a cautious approach to foreign investment mainly because she did not want FDI to distort the investment priorities of planned economic development. Not surprisingly, the Foreign Exchange Regulation Act (FERA) 1974 had strict guidelines on the sectors in which FDI was allowed and on the extent of foreign participation. The UK and USA continue to dominate the flows, although the extent of their domination has been declining. There are methodological difficulties in estimating the magnitude of flows, such as valuation issues and stock comparisons, but despite them there is no doubt as to the spurt in FDI in recent years. What is more, the flows have risen even when India’s growth has declined and inflation is high as is the case now. We shall return to this issue later. Micro data on the specific industries and firms into which FDI has flown is even harder to come by. However, by and large there has been a reasonable spread across manufacturing industries and services (especially financial services) in recent years. To the extent it has gone into manufacturing industries, however, it has gone into buying up assets of financially vulnerable Indian companies rather than setting up new production facilities. And where FDI has led to setting up new production facilities, the impact in terms of employment has not been marked.

These trends are getting even more strengthened with the pressure for FDI into non-commodity producing sectors such as multi-brand retail, insurance and real estate. The fact that FDI flows into India have not declined despite the present slow down and high rates of inflation here – a fact referred to above – reflects the strong power of global finance in seeking outlets in ‘emerging’ economies in India in a situation when the global economy as a whole is in a state of decline. This also explains why interest rates in India have to generally kept up, even though such a policy is detrimental to domestic producers. There is no strong evidence either of significant technology transfer happening or of improved export performance of those sectors into which FDI is flowing.

The euphoria over FDI is largely misplaced because it glosses over the role of multinational corporations (MNCs) in world production, exports and finance. The MNCs today are so structured today that they spread the manufacturing processes involved in making one product across several geographic locations in the world. This serves the purpose of taking advantage of raw materials and cheap labour of Third World countries while not yielding to them any tangible benefits of employment and technology. Besides, such vertical specialization in global production makes the MNCs immune to the domestic regulations of any single economy. In particular, the multinational banks which control the bulk of global finance have become the handmaiden of MNCs engaged in commodity production. With the help of transnational banks it becomes easy to liquidate durable assets and to switch operations from one country to another.

In India, FDI flows into manufacturing have not been able to prevent a recession in the manufacturing sector which, curiously, has been the focal point two decades of economic reforms. Now is the time for the country to take a critical view of its financial openness and to seriously consider domestic policies directed at mobilizing domestic capital dormant in pre-capitalist forms such as mercantile and usurious forms for productive purposes. India has never been capital-short as such. What is needed is a policy framework that encourages industrial capital and genuine entrepreneurship. FDI is neither unavoidable nor particularly desirable in the present age of MNCs and transnational banks. Overreliance on it will only make the Indian economy a gamble on global finance.

I invite everyone of you, especially the young students here, to reflect on your local and regional economies to understand the problem. Thank you.



Prof. G. Omkarnath

25/02/2013

Ramachandrapuram

















































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