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FDI as catalyst for economic growth | Business Line

FDI as catalyst for economic growth

S. Majumder
WITHIN six months of its coming to power, the UPA Government ushered in a slew of measures to attract foreign
investors. These included, among others, the scrapping of Press Note 18, raising the foreign direct investment (FDI)
cap in telecommunications to 74 per cent and opening up the construction sector.
Further, in his Budget speech, the Finance Minister, Mr P. Chidambaram, seemed euphoric about the contribution of
FDI in the economy and spoke of throwing open more sectors such as trade (retail), mining and pension. Also, for the
first time, there were proposals in the Budget to use foreign exchange reserves to finance infrastructure projects
through a special purpose vehicle.
Though the initiatives to attract FDI contradict to some extent the UPA's election manifesto, they are inevitable for
achieving higher growth, especially in an economy where domestic resources are limited.
The Government seems to have reaffirmed this, by acknowledging in the Budget that FDI is a catalysing factor for
growth, especially in the automobile, software, telecommunications and electronics sectors.
The UPA Government appears to have embarked on a new model of reforms, combining the larger use of external
resources to supplement domestic resource and initiating administrative changes. Earlier, much importance was not
given to governance, which resulted a yawning gap between reform measures and their implementation. However, the
current growth structure of the economy warrants greater investment-oriented growth, either through domestic or
external sources.
Thus far, economic growth has largely been agriculture driven. Whenever the farm sector did well, GDP grew and vice
versa. However, for 2004-05, the CSO's advance estimates reveal a different picture. Notwithstanding the marginal
1.1 per cent growth projected for agriculture, GDP is expected to rise to 6.9 per cent. This is commendable
considering that over 8 per cent growth was achieved in the previous two years as well.
In the current year, therefore, the growth impetus is not going to come from agriculture. This new growth pattern is
more or less in sync with the global trend, where growth is driven mainly by services and investments, particularly
private, made in the industrial sector. In India, the gross capital formation to GDP ratio at current prices rose from
24.8 per cent in 2002-03 to 26.3 per cent in 2003-04 the highest ever increase. This year, the ratio is expected to go
up further.
A booming stock market and rising foreign exchange reserves, through FDI and FII channels, have made it possible to
establish a new platform for investment-oriented GDP growth.
This year, FDI flows are expected to jump to $6-7 billion, from the $4.7 billion last year, and FII investments, to $9
billion. Thus, overall foreign investments are expected to touch $15-16 billion.
China's progress
China's robust economic growth has been primarily driven by large investments in industry. Industry and agriculture
account for 53 per cent and 15 per cent, respectively, of GDP compared to 22 per cent each in India's case.
The service sector's share in GDP is 40 per cent compared to 56 per cent in India, and the ratio of gross capital
formation to GDP is a high 42 per cent against India's 26 per cent. Thus, the large investments in industry have
become the engine for GDP growth, unlike in India, where growth has been largely monsoon dependent.
Despite China's high savings ratio (about 40 per cent to GDP), it has focussed on foreign investment to promote
industrial growth; FDI accounts for 10 per cent of gross fixed capital formation against 3-4 per cent in India.
Another growth booster in China is exports, which jumped to 33 per cent of GDP in 2003 from 22 per cent in 1999.
And, interestingly, FDI has played major role in this; over 55 per cent of the country's global exports come from FDIhttp://www.thehindubusinessline.com/todays-paper/tp-opinion/fdi-as-catalyst-for-economic-growth/article2171745.ece?css=print

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FDI as catalyst for economic growth | Business Line

driven firms.
During the past two years, India's exports, too, have been looking up, this despite the global slump in export growth.
The country logged 20 per cent export growth in each of the years, and this is expected to rise further to 26 per cent
in the current year.
This growth has been led by FDI-driven industries, such as automobile, auto component and electronics. Transport
equipment exports also rose at a healthy 36 per cent. And during the first eight months of the current year, the
growth rate has zoomed 71 per cent. Much of this has been because of joint ventures and foreign subsidiaries setting
up shop in the country. Almost all the automobile firms are either joint ventures or foreign subsidiaries, and a large
number of auto-parts manufacturers have foreign capital.
However, there is big difference between the two countries' FDI philosophy. While China favoured FDI to boost
exports rather than promote domestic industries, India's focus was on its import substitution programme. Again,
while China relied more on external resources, considering export as the platform for faster economic growth, India
looked more at domestic resources. FDI was seen only as a pipeline for high technology and not as an investment
support.
However, this FDI philosophy does not hold good any more. The Unctad's World Investment Report, 2004 reveals
that lately there has been a shift of global FDI towards services. About 60 per cent of global FDI moved to the service
sector in 2002. This is because the sector's increasing share in the GDP of both developed and developing economics.
India depends largely on the service sector, which accounts for 56 per cent of GDP. But contrary to the global trend,
the sector attracts only 7 per cent of FDI.
The country has enough opportunities to plough the foreign investment in this sector. Deng Xiaoping, the architect of
FDI liberalisation in China, argued in an essay that it was possible to import foreign "means of production" without
importing "relation of production".
This means opening of economy need not change the political and social system. Even Japan seeks FDI to make good
the shortfall in domestic investments. It is time, therefore, that India was more liberal in its approach to attracting
foreign investments.
(The author is a senior researcher in a Japanese MNC in New Delhi.)
(This article was published in the Business Line print edition dated March 17, 2005)

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