Unprecedented short-term foreign portfolio investments are entirely responsible for the surge
Total foreign direct investment (FDI) inflow in 2020-21 is $81.7 billion, up 10% over the previous year, reported a recent Ministry of Commerce and Industry press release. It further added, “Measures taken by the Government on the fronts of Foreign Direct Investment (FDI) policy reforms, investment facilitation and ease of doing business have resulted in increased FDI inflows into the country.” The short press release highlighted industry and State-specific foreign investment figures without detailed statistical information.
The Reserve Bank of India (RBI) bulletin, which was released a week earlier, has the details. They are conceptually more transparent and consistent. The table below summarises the main headings for 2019-20 and 2020-21 and the percentage growth rate.
What accounts for gross inflow?
“Gross inflows/gross investment” in the RBI report is the same as “total FDI inflow” in the press release, identical to the Commerce Ministry’s estimate. The gross inflow consists of (i) “direct investment to India” and (ii) “repatriation/disinvestment”. The disaggregation shows that “direct investment to India” has declined by 2.4%. Hence, an increase of 47% in “repatriation/disinvestment” entirely accounts for the rise in the gross inflows. In other words, there is a wide gap between gross FDI inflow and direct investment to India.
What is repatriation? Why is it so significant? FDI inflow increasingly consists of private equity funds, which are usually disinvested after 3-5 years to book profits (per its business model). In principle, private equity funds do not make long-term greenfield investment.
Similarly, measured on a net basis (that is, “direct investment to India” net of “FDI by India” or, outward FDI from India), direct investment to India has barely risen (0.8%) in 2020-21 over the last year.
What then accounts for the impressive headline number of 10% rise in gross inflow? It is almost entirely on account of “Net Portfolio Investment”, shooting up from $1.4 billion in 2019-20 to $36.8 billion in the next year. That is a whopping 2,526% rise. Further, within the net portfolio investment, foreign institutional investment (FIIs) has boomed by an astounding 6,800% to $38 billion in 2020-21, from a mere half a billion dollars in the previous year.
So, the mystery of the surge in gross FDI inflows is solved. It is entirely on account of net foreign portfolio investment. What is portfolio investment, and how is it included in FDI inflow? FDI inflow, in theory, is supposed to bring in additional capital to augment potential output (taking managerial control/stake). In contrast, foreign portfolio investment, as the name suggests, is short-term investment in domestic capital (equity and debt) markets to realise better financial returns (that is, higher dividend/interest rate plus capital gains). But the conceptual distinctions have blurred in official reporting, showing an outsized role of FDI and its growth in India.
If the deluge of FII inflow did little to augment the economy’s potential output, what then did it do? It added a lot of froth to the stock prices. When GDP has contracted by 7.3% (as per the official estimates released last Monday) in 2020-21 on account of the pandemic and the economic lockdown, the BSE Sensex nearly doubled from about 26,000 points on March 23, 2020 to over 50,000 on March 31, 2021. BSE’s price-earnings (P-E) multiple — defined as share price relative to earnings per share — is among the world’s highest, close behind S&P 500 in the U.S.
Thus the surge in total FDI inflow during the pandemic year is entirely explained by booming short-term FIIs in the capital market – and not adding to fixed investment and employment creation.
For years now, the government has showcased the rise in gross FDI inflows as a badge of the success of its economic policies to counter the widespread criticisms of output and investment slowdown and rising unemployment rates (especially during the last year).
As Figure 1 shows, between 2013-14 and 2019-20, the ratio of net FDI to GDP has remained just over 1% (left-hand scale), with no discernible rising trend in it. Likewise, the proportion of net FDI to gross fixed capital formation (fixed investment) is range-bound between 4% and 6% (left-hand scale). These stagnant trends are evident when the economy’s fixed investment rate — gross fixed capital formation to GDP ratio — has plummeted from 31.3% in 2013-14 to 26.9% in 2019-20 (right-hand scale). Thus, FDI inflow’s contribution to domestic output and investment remains modest.
To sum up, the Commerce Ministry press release claims an unprecedented surge in gross foreign capital inflow of $81.7 billion in 2020-21, rising 10% over the previous year. The rapid influx is evidence of the success of the economic policies during the pandemic, the government claims. Is it so? Probably not. Unprecedented short-term foreign portfolio investments are entirely responsible for the surge. And within the portfolio investment, FIIs shot up to $38 billion in 2020-21, from half a billion-dollar the previous year. The flood of FIIs has boosted stock prices and financial returns. These inflows did little to augment fixed investment and output growth.
R. Nagaraj is Visiting Professor, Centre for Development Studies, Trivandrum
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