Betting on FDI: States need to improve their business environments and implement labor and land market reforms

According to reports, the government has started discussions with a number of capital-rich countries, including Saudi Arabia, the United Arab Emirates, Japan, South Korea, the United States, and Australia, to use their large reserves of patient capital to back its infrastructure-led push to boost GDP. The government is placing a wager on the animal spirits of foreign investors to start a positive feedback loop that can help the Indian economy maintain its position as the fastest growing major economy in the world, given the moderation of public capital expenditure growth and the need for domestic private investments to pick up speed. According to a report in FE, the government is anticipated to serve as a catalyst to draw long-term, low-cost investments in the $1.4 trillion pipeline of infrastructure projects—especially when budgetary resources are limited. The government is optimistic about its ability to draw in FDI, which increased from $305.3 billion in FY05 to FY14 to $596.5 billion in FY15–FY23.

However, this bet on increasing FDI inflows is not new; rather, it dates back to the Union Budget for 2020–21 and the Economic Survey for 2019–20, which anticipated that private investments—particularly foreign ones—would do the majority of the heavy lifting. Additionally, the government has liberalized sectoral limitations in a number of areas, such as defense, to enable more investment proposals to go via the automatic route. This ongoing trend of liberalization is shown by policies such as 100% FDI limits for e-commerce, contract manufacturing, further opening up the coal sector, civil aviation, and relaxing the 30% local sourcing requirements for single brand retail. Further, if sovereign wealth funds made long-term investments in ports, water supply projects, roads, and highways, they would not be subject to taxes on interest, dividends, or capital gains, according to Budget 2020. The government is focusing FDI on sustainable energy sources including green hydrogen and wind power as well as railroads.

Whether foreign investors will be motivated enough to announce large-scale investments in the nation to spur development is the million-dollar issue. Given the nation’s stringent land acquisition regulations and the length of time required for environmental permits, investing long-term in infrastructure and green-field projects entails incurring significant risks. Although private investment is flowing to ports and airports due to the high returns, foreign equity inflows into infrastructure and development projects have been comparatively tame. Given the sensitivity of the investment climate to policy and regulatory uncertainties, tax incentives may not be sufficient. Above all, international investors look for ways to make it easier to conduct business locally, particularly in the different states. They need stronger contract enforcement because they have grave worries about state governments examining and voiding agreements made under prior administrations.

In order for a country to attract foreign direct investment, it must gain momentum in implementing long-overdue structural changes that will open up the labor and land markets. While it is true that the government is working to streamline labor rules, it is debatable whether this will result in more freedom. Implementing these measures would affect the government’s plan to invest $1.4 trillion in infrastructure to attract more foreign direct investment. The good news in this respect is that ties with nations such as Saudi Arabia, the United Arab Emirates, and Qatar are improving. These nations are contemplating using their financial influence in India in order to pursue interests other than oil and gas. This bodes well for India’s ability to draw capital pools looking for steady, long-term returns.