India’s Foreign Direct Investment Challenge: Overcoming Obstacles in the Global Supply Chain Shift

India’s Foreign Direct Investment Challenge

NEW DELHI– Over the past week, India’s benchmark stock index has hit record highs, driven by continued support from domestic investors and corporate earnings updates, highlighting the country’s strong economic momentum. But at the same time, foreign direct investment has not increased as much as expected.

In fact, foreign direct investment in India has slowed down for the second consecutive year, even though New Delhi is optimistic about the shift in global supply chains and has been vigorously pursuing foreign investment.

Observers point out that what is interesting is that India is now less competitive with China when it comes to securing foreign investment, while its competition with the United States has become more intense. India’s foreign direct investment last year was US$28 billion, a 27% decrease compared with the previous year. However, foreign direct investment in India this fiscal year is less than half of last year.

“One of the main reasons for the slowdown in FDI inflows into India is the general slowdown in FDI across the world,” said Ritesh Kumar, CEO and Chief Economist of India Macroeconomic Consultants Ltd.

“Growing uncertainty from the Indian authorities over market regulation, coupled with the relatively small size of the domestic market, is making foreign investors hesitant about India,” Singh said. “Exports may help, but a relatively strong rupee reduces India’s attractiveness as a sourcing hub.”

Not only have foreign direct investment inflows fallen sharply, but India’s share of global foreign direct investment is just over 2% and has fallen to pre-2019 levels, according to data from the latest report by Kotak Institutional Securities. The title of the company’s report is also meaningful: “India has not yet become China +1.”

“In the past, China has always dominated the world’s emerging markets, but now, as supply chains shift, India faces competition from the United States and emerging market countries that may have closer relations with the United States,” said Managing Director of Kotak Institutional Securities and co-director Sanjeev Prasad to the media.

Prasad pointed out, “The U.S. market is so huge, and the U.S. is trying to attract manufacturing back, so why do major international companies come to India? This is the challenge.”

Prasad is also the lead author of the latest report from Kotak Institutional Securities. According to the research report, India’s traditional rival China’s share of global foreign direct investment fell by 9 percentage points over the past five years, while the US’s share increased by 14 percentage points.

An Indian economic analyst, who asked not to be named, said there are many reasons for the low level of foreign investment in India in recent years. She blamed India’s cumbersome administrative approval procedures, poor record on contract enforcement, and relatively low labor productivity in the manufacturing sector.

She also said India should use free trade agreements to attract foreign direct investment. India has signed free trade agreements with Mauritius, the United Arab Emirates, and Australia, respectively, during 2021–2022, and the free trade agreement with the United Kingdom is also in the advanced stage of negotiation. But despite these trade deals, India has not seen greater inflows of foreign direct investment.

Trade experts say free trade agreements and investments can come into play when the economies involved have significantly different resources and are at different stages of development. In contrast, FTAs ​​and investments may conflict when partner countries possess similar resources and compete for the same FDI. India’s economic development and resources are almost the same as those of its free trade partners, especially those partners that signed the agreement between 2021 and 2024, and there is a clear lack of complementarity.

Experts say India needs to diversify its sources of imports and increase its participation in global value chains.

Rahul Nath Choudhury, a trade economist at Ernst & Young in New Delhi, said India has yet to reach its full potential in attracting long-term foreign capital. Improving the business environment, accelerating the signing of investment protection treaties with major sources of foreign direct investment, and allowing the rupee to depreciate gradually and steadily to stimulate exports can help India. “

India wants to become a manufacturing hub and has taken various steps to increase production. However, India soon realized that it would be difficult to achieve its production growth target by domestic companies alone, so it was imperative to invite foreign companies to invest and build factories in India. India can leverage its close economic ties with FTA partners and influence them to invest, potentially offering special incentives to investors from FTA partner countries.

Chaudhry further pointed out, “India has a GDP of US$3.5 trillion and is growing rapidly. It also has a population of 1.4 billion to provide a sufficient labor force and favorable geopolitical dynamics. All these make India attractive to those seeking to reduce their influence on the economy.” China relies on countries and companies that are attractive. As they look for alternative suppliers that can match China in terms of price and scale, India stands out as a top destination for foreign investors, ticking all the right boxes.”

But India relies heavily on Chinese imports, ranging from daily necessities such as candles to telecommunications and electronics. India’s trade deficit with China remains high and continues to expand. In the 2022–2023 fiscal year, India’s trade deficit with China increased from US$191 billion to US$263 billion. Experts believe that India urgently needs to diversify its import sources, especially the sources of key commodities. FTA partner countries can help India reduce its import dependence on China by providing stable supply channels for goods.

Despite India’s efforts, its participation in global value chains remains limited, accounting for less than 2% of global merchandise exports. India’s participation is mainly concentrated in a few industries, such as automobiles, pharmaceuticals, and mobile phones.

Experts believe that with the rise of the “China + 1” strategy, many investors are looking for alternative manufacturing bases. India can use this opportunity to become a reliable alternative to China in global trade and attract more foreign investors by enhancing production capacity and expanding supply chains.

The problem, however, is that despite India’s efforts to create a business-friendly tax system, businesses still face uncertainty related to tax liability. This is highlighted, for example, by the fact that frequent tax notices often do not withstand judicial scrutiny.

Likewise, obtaining tax benefits or refunds from government agencies can be cumbersome. Despite digitization, cumbersome administrative approval procedures can slow down efficiency and complicate processes to prevent fraud and abuse. This has led to a gap between official claims of “ease of doing business” and actual experience. Contract enforcement is also particularly cumbersome and expensive due to judicial inefficiencies. In addition, unclear regulations can lead to different interpretations, thereby increasing the cost of doing business for foreign companies.

Observers point out that India’s customs and foreign trade departments are indifferent to the plight of exporters. Arbitrary import and export regulations often disrupt supply chains and act as a deterrent to foreign investors, especially in the absence of bilateral investment protection treaties that would protect foreign investors from adverse policy changes.

Similarly, although increasing import barriers is beneficial to protecting the domestic market, they will cause conflicts and friction with trading partner countries. In addition, the Reserve Bank of India’s obsession with defending the rupee exchange rate has created further complications by making Indian goods uncompetitive in overseas markets.

Trade analysts believe that India’s potential free trade partners, such as the European Union and the United Kingdom, are important sources of foreign investment. The UAE and Australia are also both considered influential investors globally. India should leverage its free trade agreements to attract more foreign direct investment.

Recently, India signed a rare free trade agreement with four countries of the European Free Trade Association (EFTA). After 16 years of tough negotiations, the deal will see India scrap import duties on most industrial products from Switzerland, Norway, Iceland, and Liechtenstein. In return, these countries pledged to invest $100 billion in India over the next 15 years.