Does India even need foreign investment? (Yes, it really does.)

July 23, 2013
July 23, 2013

The recent departure of a string of big name investors from India, including ArcelorMittal and Berkshire Hathaway, has prompted a familiar reaction in from some corners of India—we didn’t need you anyway.

Foreign direct investment in India plummeted more than 20% in the last fiscal year, as economic growth slowed to around 5% and a series of perplexing government decisions scared outside investors away. The surprising response from some of India’s most influential business institutions has been to trumpet India’s ability to go it alone. The Economic Times suggested in an op-ed that the very government responsible for driving foreigners out should take their place instead. “Public investment must take the lead in reviving growth,” the paper wrote, somehow neglecting to mention the country’s sizable budget deficit.

A good window into the complete disconnect between India’s fiscal reality and the view of some politicians on the ground was perhaps best reflected in this statement by Tamil Nadu chief minister J. Jayalalitha on Tuesday:

The UPA government appears to be acting at the behest of foreign interests and some external rating agencies, which are frequently threatening to lower the sovereign rating to ‘junk status’ and thereby cowing down the weak UPA government at the centre, making it bend to its whims and fancies

If India’s sovereign rating was lowered to “junk,” it would, of course, be an economic disaster. The cost of funds for Indian companies would rise even further, and foreign capital flows could almost completely dry up, experts have warned.

To see the importance of FDI in a promising yet still underdeveloped economy, India needs only to look to rival China, where foreign manufacturers have helped to create huge economies of scale and transferred—sometimes unwillingly—enormous expertise.

“The reason why India needs FDI is obvious,” said Dinesh Kanabar, the deputy chief executive of KPMG in India. India needs “resources to fund the various developmental needs,” which the country does not have itself.

Infrastructure

Indian infrastructure needs about $1 trillion in investment, the government estimates, most of which it can’t fund itself. “The availability of domestic resources is limited,” explains Kanabar.

Expertise and know-how

Foreign investors don’t just bring money and jobs, they provide the building blocks for industries whose development in India lags far behind that of much of Asia. Take ArcelorMittal’s now abandoned $8.5 billion, 12 million metric tonnes a year steel plant. It would have grown the country’s existing steel capacity by more than 10%, and brought critically needed new technology to an industry that the Indian government says is “nowhere near its global competitors” in terms of technology and efficiency. Improved fuel efficiency in the steel industry, meanwhile, would also help to lower India’s oil imports, which are the main cause of the next problem.

A dangerously high current account deficit

As analyst Robin Banerjee wrote in April, when the current account deficit reached a historical high of 6.7% of GDP, “A deficit is not such a bad thing when a country is growing and requires imports to fuel growth—India believes it is comfortable with a CAD which is about 2.5% of the GDP. Anything more is a reason for concern.”

The deficit will remain at around 4% until 2015, Merrill Lynch analysts said this week.

On Monday, India moved to cut this, tightening up restrictions on importing gold, which made up about a third of the country’s current account deficit in recent years. Jewelers compared the new rules to an outright “ban” on importing gold, and imports are sure to drop. But artificially cramping the country’s gold demand, a demand with deep historical and cultural roots, is a band-aid solution.

Without FDI the rupee will continue to fall.

India’s rupee hit a record low in June, and could fall nearly 5% more in coming weeks, economist and traders told the Economic Times  this week. This currency’s could quash the government’s plans to raise money by selling private companies and further squeeze profits at Indian companies that rely on imports. It could also hike inflation and threaten growth further, Moody’s said this week.

If the high profile departure of key foreign investors isn’t quickly followed by new foreign deals in the market, there’s a chance the “India Shining” story of recent years could become what the country’s sharpest critics now call it—a mere “fantasy.

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