Economic policymakers in most countries go out of their way to attract foreign direct investment (FDI). A high level of FDI inflows is an affirmation of the economic policies that the policymakers have been implementing as well as a stamp of approval of the future economic health of that particular country. There is clearly an intense global competition for FDI. India, for its part, has set up the “India Brand Equity Foundation” to try and attract that elusive FDI dollar.
According to UNCTAD (2007), India has emerged as the second most attractive destination for FDI after China and ahead of the US, Russia and Brazil. While India has experienced a marked rise in FDI inflows in the last few years (doubling from an average of US$5-6 billion the previous three years to around US$ 19 billion in 2006-07) (Figure 1), it still receives far less FDI flows than China or much smaller economies in Asia like Hong Kong and Singapore was ahead of India (Figure 2). Not surprisingly India’s growth strategy has depended predominantly on domestic enterprises and domestic demand as opposed to FDI and export demand.
For instance, India’s FDI as
a share of GDP in 2007 represented only about 1.7 percent compared to 2.8 percent in China and even below Pakistan, and its share of gross fixed investment is 5.2 percent compared to 7.0 in China and 16.7 percent in Pakistan (Table 1). FDI has been a relatively limited source of external financing and reserve buildup in India.
Country Sources of FDI
Among countries, Mauritius has been the largest direct investor in India. Firms based in Mauritius invested over US$20 billion in India between August 1991 and July 2007 or over two-fifth of total FDI inflows during that period (Table 2). However, this data is rather misleading. Mauritius has low rates of taxation and an agreement with India on double tax avoidance regime. To take advantage of that situation, many companies have set up dummy companies in Mauritius before investing to India. Also, a major part of the investments from Mauritius to India are actually round-tripping by Indian firms, not unlike that between Mainland China and Hong Kong. The United States (US) is the second largest investor in India. The total capital flows from the US was around US$6. billion between August 1991 and July 2007, which accounted for 12 percent of the FDI inflows. Most of the US investments were directed to the fuels, telecom, electrical equipment, food processing, and services sectors. The United Kingdom (UK) and the Netherlands are India’s third and fourth largest FDI inflows. The investments from these countries to India are primarily concentrated in the power/energy, telecom, and transportation sectors. Japan was the fourth largest source of cumulative FDI inflows in India between 1991 and 2007, but inflows from Japan to India have decreased during this time period. This is opposite to the general trend. This is particularly interesting because Japan’s FDI outflows in 2006 increased by 10 percent to reach a record US$50 billion, the second highest since 1990. It is hard to explain the recent decline of Japanese FDI to India and it might as well be a temporary anomaly. India, however, continues to be one of the biggest recipients of Japanese Official Development Assistance (ODA). Most of the assistance was in building infrastructure, including electricity generation, transportation, and water supply. It is plausible that Japanese government assistance has crowded out some private sector investment from Japan.
Distribution of FDI within India
Mumbai and New Delhi have been the top performers, with the majority of FDI inflows within India being heavily concentrated around these two major cities. Chennai, Bangalore, Hyderabad and Ahmedabad are also drawing significant shares of FDI inflows. For statistical purposes, India’s Department of Industrial Policy and Promotion (DIPP) divides the...