THE REALITY BEHIND THE FALLING OF NET FDI
1. Context
India’s net FDI has declined sharply despite strong gross inflows, underlining the impact of disinvestment/capital repatriation; investor classes, modes of entry, and exit strategies can have important implications for technology transfer, industrial development, and external sustainability
2. Background of the Situation
- India’s net Foreign Direct Investment (FDI) has witnessed a sharp decline over the past few years, sparking differing interpretations.
- Critics argue that the weakening net inflows reflect a deterioration in the country’s investment environment, whereas the Chief Economic Adviser maintains that robust gross FDI inflows and increasing investment in the manufacturing sector demonstrate the underlying strength of the economy.
- According to him, the subdued net FDI figures are largely the result of higher profit repatriation by foreign investors and growing overseas investments by Indian companies.
- However, this debate fails to address a more fundamental issue. By concentrating primarily on aggregate FDI figures, both perspectives overlook the evolving nature of international capital flows and the Balance of Payments (BoP) framework that determines how investment inflows and outflows are recorded and interpreted.
- For Balance of Payments accounting, net FDI is derived by subtracting outward investment and capital repatriation from total inward FDI inflows.
- India’s net FDI, which stood at a peak of $44.0 billion in 2020–21, declined dramatically to less than $1 billion in 2024–25 before recovering modestly to $7.6 billion in 2025–26.
- During the same period, gross FDI inflows reached $94.6 billion, highlighting the significant difference between gross and net investment figures.
- It is also important to understand the evolution of India’s FDI policy. When economic liberalization was introduced in 1991, the policy framework primarily sought to facilitate technology transfer, promote exports, and conserve foreign exchange reserves.
- Over time, however, the emphasis gradually shifted toward attracting larger volumes of foreign investment, while relatively less attention was paid to the long-term external payment obligations and the overall quality of investments entering the country
3. Three types of FDI
- Foreign Direct Investment (FDI) is commonly perceived as a long-term investment that transfers technology, managerial expertise, and productive capacity to the host economy.
- In reality, however, FDI consists of different categories of investors, each characterized by distinct objectives, investment strategies, and exit horizons.
- The first category is Real Foreign Direct Investment (RFDI), which includes conventional multinational corporations possessing advanced technology, globally recognized brands, and the expertise required to establish manufacturing and service operations.
- Such investments are typically strategic in nature and involve long-term commitments to the host country.
- The second category comprises financial investors, such as private equity funds, venture capital firms, sovereign wealth funds, and institutional asset managers.
- Unlike traditional multinational enterprises, these investors primarily seek capital appreciation and generally plan to exit their investments after achieving targeted returns.
- The third category consists of diaspora investments and Special Purpose Vehicles (SPVs). These investments often involve funds mobilized overseas and routed through offshore financial centres.
- In some cases, they may also include the practice of round-tripping, where Indian capital is invested abroad and subsequently reinvested into India through foreign jurisdictions.
- Data on remittance-level FDI for the four-year period from 2022–23 to December 2025–26 indicate that Real FDI accounted for approximately 41.9% of effective inflows. Financial investors contributed a comparable 40.5%, while the remaining 17.6% originated from diaspora investments and SPVs associated with India.
- The investment approach of financial investors naturally implies eventual exits, which can lead to significant capital repatriation.
- An illustrative example occurred in 2025, when Temasek of Singapore exited its investment in Schneider Electric India Ltd., reportedly earning $6.4 billion from an initial investment of $637 million made in 2020.
- During the same calendar year, total recorded divestments reached $52 billion, of which 45 major exits by foreign private equity and venture capital firms accounted for nearly $29 billion in capital outflows.
- An examination of effective FDI inflows also reveals a declining trend in investment directed toward India’s manufacturing sector over three successive four-year periods.
- Particularly noteworthy is the fact that Real FDI in manufacturing represented only 10.6% of total effective inflows during the latest four-year period, suggesting a reduced share of long-term productive investment in this crucial sector
4. Not All FDI Represents Fresh Capital
- One significant limitation of relying on gross FDI figures is that they often combine genuine new investments with various corporate restructuring transactions.
- These include intra-group ownership transfers, mergers and acquisitions, share swaps, and the conversion of previously issued non-equity instruments, such as External Commercial Borrowings (ECBs) and convertible debentures, into equity.
- Although such transactions alter the ownership or capital structure of companies, they do not necessarily bring additional foreign capital into the Indian economy.
- As a result, gross FDI statistics may overstate the amount of fresh investment actually entering the country.
- Between 2014–15 and December 2025–26, India received approximately $560 billion in equity inflows. However, an estimated $40 billion of this total consisted of accounting and restructuring transactions rather than new capital injections.
- Consequently, these figures should be interpreted with caution when assessing the true magnitude of foreign investment.
- Moreover, a few exceptionally large corporate deals can significantly influence annual FDI numbers and sector-wise trends.
- High-value transactions involving companies such as Bosch and Meesho Technologies illustrate how individual restructuring or ownership changes can distort the overall picture of FDI inflows, even when they do not generate fresh investment for the economy
5. Disinvestment as a Key Driver of Declining Net FDI
- Before examining the reasons behind India’s low or even negative net Foreign Direct Investment (FDI) in certain periods, it is important to clarify a common misconception. The official argument that profit repatriation is primarily responsible for reducing net FDI can be misleading.
- According to the Balance of Payments (BoP) framework, profits remitted abroad in the form of dividends are classified as investment income under the current account.
- While these payments contribute to widening the Current Account Deficit (CAD), they do not directly affect the calculation of net FDI.
- Instead, the principal factor behind subdued net FDI is disinvestment and the repatriation of capital, both of which are recorded in the financial account of the BoP.
- Similarly, the recent rise in Outward Foreign Direct Investment (OFDI) deserves a more nuanced interpretation than simply viewing it as evidence of the growing maturity of Indian corporations.
- Between 2023–24 and 2025–26, nearly 45% of India’s outbound investment, amounting to $65 billion, was directed toward the financial, insurance, and business services (FIB) sector.
- Among the destination countries, Singapore accounted for 27% of the total, while the United Arab Emirates (UAE) received 11%.
- A substantial portion of these investments was routed to holding companies and Special Purpose Vehicles (SPVs) rather than directly into operational businesses.
- These multidirectional capital movements, whether through GIFT City or other offshore jurisdictions, suggest that outward FDI can represent both genuine international expansion by Indian firms and the recycling or return of previously shifted capital.
- Consequently, a rise in OFDI should not automatically be interpreted as a sign of corporate maturity alone.
- While many Indian companies invest abroad to acquire technology, resources, or global market access, some investments may involve the re-routing of capital through different jurisdictions before it eventually returns to India
6. Understanding the Channels of Capital Outflows
- Between 2022–23 and 2025–26, India witnessed substantial FDI inflows, but these were accompanied by equally significant outflows through various current and capital account transactions.
- Although gross inward equity FDI amounted to $317.8 billion (or $230.6 billion after excluding reinvested earnings), the pattern of associated outflows presents a far more intricate picture.
- A major component of these outflows was disinvestment and capital repatriation, recorded under the capital account, which totalled $178.9 billion. These outflows were largely driven by financial investors exiting their investments through mechanisms such as secondary market sales, strategic stake sales, initial public offering (IPO) exits, and share buybacks.
- They also included Offers for Sale (OFS) by foreign promoters in companies such as Hyundai and LG. In addition, some traditional foreign investors divested their holdings, as illustrated by Wistron’s sale of its Indian operations to the Tata Group.
- Another significant outflow arose from dividend remittances, which are recorded under the current account.
- During this period, multinational enterprises (MNEs) and their affiliates transferred approximately $118.9 billion abroad as profits distributed to their parent companies, excluding the portion retained as reinvested earnings.
- Outflows were also generated through payments for intellectual property rights (IPR), including royalties and licensing fees.
- These payments, attributable to MNE subsidiaries and affiliates and estimated at $46.6 billion (assuming they constituted about 75% of total IPR payments), often serve as an alternative mechanism for transferring profits to parent entities.
- Furthermore, Indian entities collectively remitted around $250 billion toward technical, consultancy, and service-related payments.
- However, distinguishing the share attributable to foreign-owned enterprises from that of purely domestic firms remains difficult due to data limitations.
- Even after excluding Outward Foreign Direct Investment (OFDI) and payments for technical and consultancy services, the combined outflows arising from disinvestment, dividend remittances, and IPR-related payments amounted to approximately $344.4 billion
- This indicates that for every dollar of fresh foreign investment entering India (excluding reinvested earnings), nearly $1.50 flowed out through these channels.
- The trend has become increasingly pronounced over the past decade. Between 2014–15 and 2017–18, about 56 cents flowed out for every dollar of fresh inflow.
- This ratio increased to 70 cents during 2018–19 to 2021–22 and has since risen to its current elevated level, reflecting a growing imbalance between fresh capital inflows and associated outflows
7. Way Forward
The discussion above illustrates that public debates on Foreign Direct Investment (FDI) often rely on an incomplete understanding of its nature and implications. FDI is not a homogeneous form of investment; rather, it comprises diverse categories of investors, varying modes of entry, and different exit strategies, each of which has distinct consequences for technology transfer, industrial development, and the country’s external sector sustainability. Moreover, the manner in which global FDI statistics are compiled and reported further complicates their interpretation. Therefore, a comprehensive assessment of FDI requires looking beyond headline figures and examining the quality, composition, and long-term economic impact of these investment flows
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For Prelims: Foreign Direct Investment (FDI), initial public offering (IPO), Current Account Deficit (CAD)
For Mains: GS III - Economy
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Previous Year Questions
1. Both Foreign Direct Investments (FDI) and Foreign Institutional Investor (FII) are related to investment in a country. (UPSC CSE 2011)
Which one of the following statements best represents an important difference between the two?
A.FII helps bring better management skills and technology, while FDI only brings in capital
B.FII helps in increasing capital availability in general, while FDI only targets specific sectors C.FDI flows only into the secondary markets, while FII targets primary market
D.FII is considered to the more stable than FDI
Answer (B)
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Source: The Hindu
