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 Such funds can be withdrawn from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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