There
is so much of talk going around in all circles regarding FDI. Politicians, for
obvious reasons, speak a language of their own, driven by ulterior motives.
Most of the times, they are not even knowledgeable to understand the long term
consequences of the populist measures and policies they adopt. It would be in
the fitness of things if the whole thing is explained in simple and elementary
terms.
FDI
is Foreign Direct Investment. Direct Investment is of two types: Domestic Direct Investment (DDI) and Foreign Direct Investment(FDI). DDI is done in domestic currency (rupee in India) and FDI brings in
foreign exchange.
Now,
the question arises why FDI. The need for FDI is justified only in two
situations – (1) when DDI is inadequate or (2) when foreign
exchange is required.
On the DDI front, the position as obtained in our country is fairly sound.
Banks are flush with funds; the domestic savings rate is one of the highest in
the world; market capitalisation, constantly on the rise, makes available
investible funds; and DFIs have huge unutilised funds waiting to be deployed in
feasible projects. It is gung-ho all around. Therefore, domestically speaking,
there is no shortfall of funds for investment.
As
for foreign exchange, it is either an asset or liability, depending
upon its repatriability. If it is repatriable (i.e., to be returned or repaid
in the form of foreign exchange itself), it is a liability. If not, it is an asset. This way, only
three sources of foreign exchange – (1) exports of goods and services, (2) NRO
accounts in banks and (3) Foreign Aid — qualify as assets. The rest are liabilities like FCNR & NRE deposits of NRIs;
FDIs; FIIs and foreign exchange loans from foreign governments and agencies. For convenience, let’s call one asset
foreign exchange and the other liability foreign exchange. Some people choose
to call them non-debt and debt inflows respectively.
FDI is a debt inflow
or liability foreign exchange. Why? Simple, because the profits or returns it
generates will have to be repatriated in foreign exchange. Secondly, all the
men, material and merchandise imported in the years to come will have to be
paid in foreign exchange. Finally, at the time of winding up/selling off, the
proceeds will flow out of the country in foreign exchange. And, it is noteworthy here, all this
will end up in the outflow of foreign exchange, many times more than the
initial inflow. So, every FDI is a clear-cut case of liability foreign exchange.
All
the above is about the supply-side of foreign exchange. Now, let’s examine the
demand side. The question is – why is foreign exchange needed at all? Based on
long-term benefits to the economy, the demand for it can be classified into
consumption and construction. Consumption demand is the demand for foreign
exchange to import consumption items like gold, oil, tourism and FMCG — all
those areas where funds are just blown. On the contrary, ‘construction’ stands
for all those areas which promote exports, substitute imports, strengthen the
infrastructure of the country and make it more competitive globally.
So,
we have the demand for foreign exchange classified into two and its supply also
into two. This can be neatly depicted graphically in a Foreign Exchange
Desirability Matrix.
The
table makes it amply clear that Asset Foreign Exchange casts no negative impact
on the economy, regardless of whether it is used for construction or
consumption purposes. However, liability foreign exchange needs to be
restricted to ‘construction’ purposes, as the consequences of putting it to
consumption needs are grave.
Now,
why should we go in for liability foreign exchange, like FDI, at all, if it is
not for any export promotion, import substitution or any capacity construction
purpose? Well, if we indulge in the luxury of blowing liability foreign
exchange on non-developmental consumption items, we’ll end up worsening our
foreign exchange debt position (we are already in the doldrums with mounting
pressure on our capital account of balance of payments, owing to increasing
deficits in our balance of trade account year by year).
In
fact, until we have any project/avenue in hand which will, in times to come,
yield foreign exchange more than its repayment schedule warrants, the inflow of
liability foreign exchange should be outrightly avoided.
The
service sector is comprised of marketing (wholesale and retail), banking,
insurance, civil aviation, education, tourism, medical & health,
telecommunication and software, etc. All these fall either in the construction
category like education, medical and health, telecommunication and Software or
consumption like marketing, insurance, banking and tourism.
Incidentally,
in marketing, there is nothing like technology. It’s all about consumption,
where the sole elements are Brand and Supply Chain Management; again nothing
basic or infrastructural or technology enhancing. Further, the question arises
— will FDI in sectors like retail, single brand, banking or insurance enhance
our foreign exchange earning capacity? A big NO. Do they bring technology to
the economy? Again, a big NO. Hence, FDI in ‘consumption’ sectors deserves to
be outrightly rejected. If it is not, it would simply mean the government is
not working in the interest of the economy, but is unscrupulously catering to
vested interests.
IMPORTING TECHNOLOGY
They
say, had FDI not come in, our automobile, telecommunication, aviation, banking
and many other industries would not have reached global standards. I would say
that instead of allowing foreign capital to set up shop here, the country
should have used foreign exchange to just import technology, if needed; and set
up the same industries with domestic capital. No liability foreign exchange; no
profits going out of the country; domestic consumers getting the same products;
and the fruits of exports being reaped by domestic firms and not foreign — all
the way a win-win situation for us.
But,
being blind to the undercurrents, we instead allowed foreign firms to set up
bases here, milk the domestic market and carry back huge profits. The foreign
exchange that flowed in by way of FDI was blown in consumption areas like gold
and oil.
In
the ensuing debate, lots of comparisons are being made with the U.S., the U.K.,
China and Japan. The question is: are we at the same level of development to
indulge in the luxury of comparing ourselves with them?
With
no apparent gain for the economy in the long-run on the table, there cannot be
a more foolish act for any country than inviting foreigners to set up shop on
its own territory. First, it is a clear signal of allowing them to reap profits
here and take them back. Second, it is telling the world, loud and clear, that
we, by ourselves, are incompetent and inefficient. If a foreign entity pushes
for entry in the economy, it will still make sense. It wants to expand its market
and reap profits. But what is the compulsion for a host country to insist that
a foreign entity come and set up shop here?
Historically,
no economy has ever developed on foreign capital. In the industrial revolutions
of various nations, the crucial factors that have been instrumental are (1)
indigenous mobilisation of resources, (2) domestic technological development
and application (3) strategic management and (4) support from the governments,
mostly to ward off external pressures. Cases of foreign investment are few and
far between.
Let
us keep in mind that foreign exchange is both a boon and bane, to determine
which each of its inflow needs to be individually assessed for its costs and
benefits, before allowing it.
(Professor
Anupam Bhargava, a PhD in Management, is a former AGM of SBI. He is now Adviser
and Research Guide at Rajasthan Vidyapeeth (Deemed University), Udaipur.
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