India recently marked 30 years of its economic reforms, popularly known as LPG (Liberalisation, Privatisation, and Globalisation). These were monumental in opening up India’s Economy to the rest of the world. As the then Finance Minister, Manmohan Singh, said during his 1991 speech, “No power on earth can stop an idea whose time has come,” the country has gone through tectonic shifts in its fundamentals of economics.
These reforms were also crucial in bringing in Foreign Direct Investment (FDI) to the country. FDIs are investments made by foreign entities in the form of controlling ownership in a different country. However, what is its impact on the Economy?
Impact on Economy
FDIs are essential in the country’s long-term growth as they strengthen balance sheets (raising assets) while also increasing the per capita income. It’s a cyclic chain. Once an entity invests in the country, it directly impacts the company per se and the Economy overall.
Once the company’s assets have risen, it has more capital to invest in its betterment – expansion, recruitment, marketing, sales, and so on. This will ultimately help in increasing the profits of the company.
Moreover, as the entity expands, it hires more people and increases wages, which increases per capita income. Consumption also increases as the employees have more money with them. This indirectly helps the tax revenues, which ultimately gives rise to government spending.
Overall, this gives a rise in the Gross Domestic Product (GDP) of the country. Moreover, FDIs are an excellent way to reduce the cyclic effect of poverty. According to Late Prof. Harvey Leibenstein, professor at Harvard University, a stimulus, like an FDI, maybe a way around his ‘Theory of Critical Minimum Effort.’
Quantity Theory of Money
According to the Quantity Theory of Money, the price level in the economy is directly proportional to the amount of money in circulation. An FDI may stimulate exports, increasing the Balance of Payment, which allows the rupee to appreciate against the dollar. As forex reserves increase, RBI assets increase, causing the money supply to grow and inflation to rise.
There has been a total FDI of US$ 81.72 billion during the financial year 2020-21, which has been the highest ever attracted FDI inflow, and it is 10% higher as compared to the last financial year 2019-20 (US$ 74.39 billion). The Ministry of Commerce & Industry has released this data from, Government of India.
State-wise, Gujarat gets the highest FDIs, followed by Karnataka and Maharashtra. ‘Computer Software & Hardware’ has emerged as the top sector during Financial Year 2020-21 with around 44% share of the total FDI Equity inflow followed by Construction Activities and Services Sector.
However, not all is rosy in the domestic market when FDIs come into the picture. It harms domestic companies by offering their goods and services at a more competitive rate. Moreover, foreign investors can be volatile as they mostly look at profits as their primary goal. In case a better opportunity is spotted by them, they might shift there.
FDIs are essential cogs of the wheel in the country’s economy, which primarily helps it improve and progress further.