The newly re-elected Narendra Modi government is grappling with a slowdown in foreign direct investment inflows – a vital stepping stone in India’s bid to become a global economic powerhouse and boost job numbers in the domestic market to fulfil a much-publicised election promise.
However, things are not looking bright for Mr Modi or for Nirmala Sitharaman, his choice for the top job at the finance ministry, as India has just lost the crown for being the world’s fastest-growing major economy, the latest government data shows.
“A slowdown in FDI inflows has indeed thrown up fresh policy challenges to the new government,” says Mahesh Singhi, the founder and managing director of Singhi Advisors, a Mumbai global investment banking company.
FDI equity inflows into India declined for the first time in six years in the financial year between April 2018 and March 2019, down by 1 per cent on the previous year to $44.37 billion, according to data released last week by India’s Department for Promotion of Industry and Internal Trade.
This comes as Prime Minister Narendra Modi was sworn in for a second term on Thursday after his Bharatiya Jananta Party resumed control of New Delhi following a landslide election victory.
Mr Modi is now under enormous pressure to re-energise India’s slowing economy.
The severity of the challenges that the country’s economy is facing were highlighted on Friday, when official data revealed that GDP growth in the quarter between January and March declined to 5.8 per cent from 6.6 per cent in the previous quarter, dragged down by factors including weakening consumer spending.
The slowdown was much sharper than analysts’ forecast of around 6.3 per cent. It also means that India loses its title of the world’s fastest-growing major economy to China.
Attracting foreign investments could be one way of getting the title back from China, but investors will be wary about injecting funds into the third-largest Asian economy after a faster-than-expected slowdown in growth.
“A main factor that has been making foreign investors cautious about stepping up investment in India is the shrinking domestic expansion,” says Mr Singhi. “The primary task for the government is to put the economy back on a high growth track and getting the plot back to the consumption story.
“There is also an urgent need to deepen reforms [to create a more attractive environment for foreign investors] in sectors including real estate and retail.”
All of this means that the government has its work cut out – particularly the newly appointed finance minister, Ms Sitharaman, who was a surprise choice for the role. She was formerly the defence minister, and has been described by Indian media as “a political lightweight”. Investors are watching closely to see how she will manage India’s economic problems.
Under Mr Modi’s government, which first came to power in 2014, attracting foreign investment has always been high on the agenda, and that is not going to change.
“We expect the fiscal consolidation, infrastructure spending, FDI focus and strong external affairs policies to continue,” analysts at Morgan Stanley wrote in a research note.
Over the past five years, Mr Modi has conducted a number of overseas trips in a bid to woo investors, including high-profile visits to the US, the UK, the UAE and Japan.
Before slowing last year, FDI soared under his premiership, hitting a record of $44.86bn in the financial year to the end of March 2018.
In a bid to lure more investors, restrictions on foreign investment were relaxed under the Modi government’s first term in sectors including retail, aviation and defence. Karan Mehrishi, the lead economist at Acuite Ratings & Research says this should have a positive impact on the FDI inflow in these sectors.
However, the picture is not so rosy for sectors including telecoms, pharmaceuticals, and power, where FDI declined sharply in the year to March compared to the previous year, the official data revealed.
Analysts say that the steep declines can be partly attributed to problems specific to these sectors. For example, FDI equity inflows into telecoms were down by more than half on the previous year to $2.6bn, amid major price wars and large amounts of debt in the sector, which drove some companies out of business and forced others to merge.
There were sectors that gained, however, including the services sector, the automobile industry and the computer software and hardware segments, government figures show. However, looking at the overall FDI picture in India, Mukesh Jain, a corporate lawyer and founder of Mukesh Jain & Associates in Mumbai, says the dip is “transient”.
Many experts point out that it was partly owing to the uncertainty that gripped investors in the run-up to the six-week-general election, which concluded with BJP’s declaration of victory on May 23.
“FDI is a medium to long-term commitment, so people postponed those decisions. It’s not a negative vote for India – people were simply waiting for clarity,” says Mr Jain.
Now, with a stable government in place, this should help to generate interest once again and prompt investors to move ahead with plans, he says.
But there are other obstacles that have driven away foreign investors, including volatility in the rupee. The much-needed land and labour reforms in the country, which need to be tackled by the central and state governments to make it more appealing for foreign investors, is another issue. Successive governments have avoided addressing these issues as they don’t want to upset their voter bank, he says.
“They need to give attention to these two basic areas [land and labour reforms], which are fundamental to the ease of doing business,” says Mr Jain. “The ability to acquire land and reduce the labour force when they need to is crucial for foreign investors.”
However, Sanjeev Prasad at Kotak Institutional Equities points out that these reforms are unlikely to be implemented in the near future as the Modi government did little to move in that direction in its previous tenure, despite having a comfortable majority in parliament.
There is also the need for a “review of the role of the government in business, including privatisation of public sector banks, and changes to ownership and pricing policies to encourage greater FDI and private investment in the critical infrastructure sector”, he says.
There is strong opposition from smaller businesses for big foreign companies to enter the market, which they believe are impossible to compete with. These small businesses make up the backbone of the Indian economy and employ a sizable chunk of India’s voters.
Small traders and retailers last year took to the streets against Walmart’s decision to buy a majority stake in the Indian e-commerce company Flipkart, and governments, although willing to bring more investment into India, have to be sensitive to their own markets and the future of smaller enterprises.
Economists, however, say that FDI ultimately helps to create more jobs and this should be reason enough why India should pursue more FDI aggressively. Official data released on Friday confirmed a report that was leaked to the Indian media earlier in the year, which revealed that the unemployment rate in the year to the end of June hit a 45-year high.
Therefore, a pick up in FDI cannot come too soon, and an improvement in inflows could be around the corner, analysts say.
“The many policy steps taken by the government during the past five years will start showing results,” says Mr Singhi. “Along with this, further deepening of reforms leading to a revival in economic growth will put India back on the top of the FDI map.”
