FDI: Cycle seems to be turning

Typically after a slowdown, inflows take nearly 10 quarters to revive.

While demand destruction is an irrefutable reality, the long-term levers of growth are rebounding, even if growth slows down in the near-term. This year has been dominated by the three big ‘I’s’ — interest rates, inflows and inflation. While the battle against inflation is being waged primarily through interest rate rises, long-term inflows are showing signs of revival.

After falling 25 per cent in last financial year, foreign direct investment (FDI) inflows into India are seemingly picking up. Gross FDI inflows rose 43 per cent year-on-year to $3.1 billion in April alone this year, the highest inflows in a month since August 2009. The inflows are broad-based, with the strongest inflows into the services and manufacturing sectors.

Sonal Varma, Nomura’s India economist, believes while one month does not make a trend, there are reasons to believe this may be the start of a new phase. The reason behind this belief is that FDI cycles typically take three years to revive, after a slowdown or economic crisis. If one looks at the third quarter of 2008 (July-September), FDI inflows peaked at $7 billion in that period. Following this principle, a revival in inflows seems more than a monthly blip.

Eonomists believe FDIs, which are stickier than volatile portfolio flows, are likely to be supported by several large proposals in the oil & gas, metal and telecom sectors. Also the gradual opening up of the retail sector will also lead to increased inflows over this and the next financial year.

According to UNCTAD’s global investment trends report, FDI inflows to major emerging markets such as China, Thailand, Brazil, Hong Kong and Mexico increased in a range of 6-53 per cent in 2010, with Malaysia, Indonesia and Singapore recording a staggering 120-410 per cent rise. During the same period, FDI inflows into India contracted by 31.5 per cent.

Of the $12 billion decline in FDI inflows between 2008 and 2010, around 60 per cent can be accounted for by weak FDI into services sectors, such as computer software and hardware, financial services, banking and construction activities. The sharp drop in FDI into banking and other financial services isn’t surprising as the crisis led firms to restructure operations. Economists believe the current pattern of inflows resemble periods after similar slowdowns in the past.