Early warning for reform

Govt must reform quicker to tackle global adversities

The Department for Promotion of Industry and Internal Trade has released its latest figures for foreign direct investment (FDI) in India over the period between April and September 2022. These show a sharp downturn in FDI flows. Over the period, they stood at $26.9 billion as compared to 31.2 billion in the equivalent six months of the previous year. This year-on-year decline of 14 per cent or so represents a sequential decline from the previous period of even greater magnitude. Trade growth so far this year has not been particularly encouraging. Foreign portfolio investment into India has also seen a decline; inflows into equity in particular went down by nearly a quarter in the April-September period as compared to the same time interval in the previous year. Within these broader foreign inflows, the overall FDI category is considered relatively stable. A sharp fall in such inflows is a reminder that this assumption of stability is and always has been unwarranted.

The global macro-economic situation has turned adverse for countries like India which are dependent for their economic stability on sustained inflows of capital. Tightening interest rates in the global north have caused a steady return of capital back to the developed world. Higher rates will also dampen demand in the developed world, which will in turn reduce export demand for Indian products and affect the balance of trade negatively. The current account deficit (CAD) in the April-June quarter of 2022-23 has widened to 2.8 per cent of GDP. Government officials have said the CAD for the entire year may cross 3 per cent and may be as high as 3.2 per cent, while some independent estimates would take that figure up to 3.5 per cent. This represents a deficit of $40-50 billion, which is not large compared to India’s foreign exchange reserves of just under $550 billion. The reserves are used not only to protect against a sudden emergency that would leave India vulnerable on the external account, but also — more covertly — to manage the decline of the rupee. Greater pressure on the reserves due to a high CAD reduces options available to the Reserve Bank of India when it comes to currency management.

The government has prioritised macro-economic stability, rightly interpreting such stability as essential to lay the foundations for sustained private investment and growth. This achievement of stability is now under threat, partly due to adverse global factors. This means that if the government is to ensure that the coming fiscal year insulates India from the tempests blowing through the global macro-economy, it must ensure that the country is an even more attractive target for foreign investment and a more productive, export-focused economy. The momentum that has been built up towards productivity increases must not be slowed. In addition, financial, legal and administrative reform that further integrates the Indian financial markets with their global peers is essential. These will partly counteract the effects of the draining out of dollars back to the global north as part of the turn in the business cycle.