Weak FDI inflows sting Indian business

As foreign direct investment dries up in the global economic downturn, Indian companies are finding their growth plans getting derailed, with a study warning that the situation is unlikely to change anytime soon.

The study by the Confederation of Indian Industries titled 'Global economic crisis: India's recovery' says any expectation of high levels of FDI into India would be unrealistic. Similarly, FII investments would be minimal, perhaps nil, it said.

The findings may come as a blow to Indian industry, which, with the financial liberalisation of the last few years, had come to increasingly rely on foreign financing - particularly external commercial borrowings, to fund its growth plans.

The CII said India must depend on domestic resources to support investment in infrastructure, agriculture, industry and services sectors, which were the most important for India's recovery. "Net FII investment end-February this year was $51 billion at book value. India needs to plan on the basis of a steady fall," the study said.

It claimed that stimulus packages would have a limited impact because the problem is far deeper and widespread globally. Such packages would need to be made with care and caution to avoid fiscal bankruptcy, it said.

"Fiscal caution needs emphasis. India cannot take the risk of returning to high levels of deficit and debt. And, it need not. High deficit works against RBI's attempt to reduce interest rates. Long term yields have refused to decline despite the fall in inflation and interest rates," it stated.

In earlier years, aggregate FDI inflows increased 30 per cent in 2007 over 2006. During January-July 2008, FDI inflows increased more than two and a half times over the same period in 2007. But this was before the full impact of the financial crisis was felt.

Shrinking funds flow
A recent RBI release shows that the inflow of ECBs and foreign currency convertible bonds slowed considerably in October 2008 - down 60 per cent from Rs283.49 crore in September to Rs112.52 crore.

Apart from the decline in ECBs, domestic funds too have become scarce and increasingly dear following a rise in interest rate.

The service sector has been the prime mover of India's gross domestic product in recent years and foreign investors so far never had doubts about its potential. The situation has, however, changed drastically in the current year. The poor performance of the software companies dampened the mood of the foreign investors and FDI inflow to software sector has fallen sharply.

The sector received only Rs5,727 crore FDI in the first seven months of 2008 against Rs10,215 crore in 2007. Its share in total FDI inflow has fallen to only 5.8 per cent in 2008. The service sector, however, has continued to enjoy a steady inflow of FDI. Its share in total inflow has increased further 23.2 per cent during January-July 2008.

OECD review of India's FDI
Days after G-20 nations agreed to crackdown on tax havens where nearly $11 trillion is parked, the Organisation of Economic Cooperation and Development (OECD) has begun a review of India's FDI policy to suggest measures that will ease sector-specific ceilings as well as look into issues of round tripping.

The first-of-its-kind review-OECD Investment Policy Review of India-is expected to propose measures to make the FDI policy more open and transparent, methods to improve data maintenance, clauses on 'security', and also look into the dependence on investment that is 'round-tripped' from tax havens.

Round tripping is a common system of tax evasion where an investor uses the tax holiday advantage of Mauritius or some other country with which India has a double taxation avoidance agreement takes money out of India, only to bring it back disguised as foreign investment.

The money is routed through firms set up in these tax havens. Mauritius accounts for as much as 43 per cent of the total FDI equity flows into the country. Cyprus, another tax haven, accounts for three per cent. India's revenue department has been monitoring the capital flow from these two countries and has routinely objected to FDI proposals from there on fears of tax evasion.

Last week, the OECD had come out with a list of countries that act as tax havens including Mauritius, Cyprus, Switzerland, Luxembourg, Liechtenstein, Austria, Belgium, Chile, Brunei, Guatemala, Singapore, Cayman Islands, Bermuda, Netherlands, Liberia, Bahrain and the Bahamas. (See: G-20 cracks whip on tax havens; OECD publishes blacklist)