THERE is good news for India Inc. Despite the global financial crisis, inflow of foreign capital to the country has increased sharply in 2008. The aggregate inflow of foreign direct investment (FDI) has more than doubled in 2008 over 2007. The stake was enormous. For, Corporate India’s dependence on foreign funds has increased steadily in recent years as the easing out of norms for FDI, especially; external commercial borrowings (ECB), over the years had led to a dramatic rise in the inflow of foreign capital in India.
Granted, there are reasons for caution as these data relate to 2008 only and the situation may have changed in 2009. After all, the crisis is not over yet. In fact, RBI’s recent release shows that the inflow of ECB and foreign currency convertible bonds (FCCBs) has slowed down considerably in 2009 – down 73% from $1,702 million in November 2008 to $453 million in February 2009.
The decline in ECB is feared to affect the investment plans of the companies. After all, a large number of companies use this fund to import capital goods. In fact, of the 32 companies which raised funds through ECB and FCCBs last February through automated route, as many as 15 did so for import of capital goods for expansion of capacity or for modernisation of plants.
That India’s investment activities in recent years have largely been financed by foreign sources may be seen in the sharp rise in FDI inflows. Aggregate inflow of FDI has increased more than nine times during last five years from Rs 14,781 crore in 2004 to Rs 1, 39,725 crore in 2008.
While improved macro fundamentals in recent years has strengthened the confidence of foreign investors in Indian industries, opening up of new areas and changes in government policy towards FDI must have engineered this jump in foreign capital inflow. That opening up of new areas has given foreign investors more investment options is reflected in the changing destinations of foreign capital. The service sector, which was a restricted domain for foreign capital in the past, for example, has become the most sought after area of late.
The service sector has been the prime mover of India’s gross domestic product in recent years and foreign investors never had doubts about its potential. However, policy restrictions in the past did not allow them to invest in this industry as much as they willed. Now that restrictions have been eased out, FDI has flowed in to this industry as never before. It accounted for a huge 24.3% of the total FDI inflow in 2008. In actual terms, the FDI inflow to this sector has grown 32 times in last five years from a mere Rs 1,074 crore in 2004 to Rs 33,947 crore in 2008. The second most important destination of FDI in 2008 was telecommunication. It accounted for about 8.3% of the total FDI flowing into the country in 2007.
But while the service sector and the telecommunication industry have increased their share in total FDI inflows in the country in 2008, the software industry has gone down the ladder further. The poor performance of the software companies dampened the mood of the foreign investors and FDI inflow to software sector has fallen sharply. The sector received only Rs 7,810 crore FDI in 2008 against Rs 10,214 crore in 2007. Its share in total FDI inflow has fallen to only 5.6% in 2008 against 16% in 2007.
But as the financial crisis continues, the big question is: Will FDI inflow to India grow at the same rate in the coming months? After all, the service sector, which has been the main contributor to GDP growth, was the biggest gainer of the rise in FDI inflow in recent years. Now if the FDI inflow slows down, it will affect the growth of the service sector and in turn, the GDP growth.
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