Model Answer
0 min readIntroduction
Globalization has led to increased capital flows across borders, primarily in the form of Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). Both are crucial for economic development, but they differ significantly in their nature and impact. India, in recent years, has actively sought to attract foreign investment to boost economic growth, create employment, and enhance technological capabilities. The government has consistently emphasized the preference for FDI due to its long-term benefits and stability, as opposed to the volatile nature of FPI. This essay will delve into the reasons why FDI is preferred over FPI and examine the government’s initiatives in this regard.
Understanding FDI and FPI
Foreign Direct Investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. It typically involves establishing business operations or acquiring substantial ownership in existing firms. FDI is considered a long-term commitment and reflects a belief in the host country’s economic prospects.
Foreign Portfolio Investment (FPI), on the other hand, refers to the purchase of financial assets, such as stocks and bonds, in a foreign country without establishing any long-term control or interest. FPI is driven by short-term returns and is more susceptible to market fluctuations.
Why FDI is Preferred over FPI
Several factors contribute to the preference for FDI over FPI:
- Stability and Long-Term Commitment: FDI is generally more stable than FPI. FDI investors have a long-term perspective and are less likely to withdraw funds at the first sign of trouble. FPI, being driven by short-term gains, is prone to ‘hot money’ flows, leading to volatility in financial markets.
- Technology Transfer and Skill Development: FDI often brings with it advanced technology, managerial expertise, and skills, which can enhance the productivity and competitiveness of the host country’s industries. FPI rarely involves such transfers.
- Employment Generation: FDI creates direct and indirect employment opportunities in the host country through the establishment of new businesses and expansion of existing ones. While FPI can contribute to job creation in the financial sector, its impact on overall employment is limited.
- Balance of Payments: FDI has a positive impact on the balance of payments. It brings in foreign exchange, reduces the current account deficit, and contributes to export growth. FPI can lead to both inflows and outflows, making its impact on the balance of payments less predictable.
- Control and Governance: FDI investors typically exercise control over the businesses they invest in, leading to improved corporate governance and management practices. FPI investors have limited control and influence.
Comparative Analysis: FDI vs. FPI
| Feature | FDI | FPI |
|---|---|---|
| Investment Horizon | Long-term | Short-term |
| Control | Significant control/ownership | Limited or no control |
| Stability | High | Low |
| Technology Transfer | High probability | Low probability |
| Impact on BoP | Generally positive | Variable |
| Volatility | Low | High |
Government Initiatives to Promote FDI
The Indian government has undertaken several initiatives to attract FDI:
- Liberalization of FDI Policy: The government has progressively liberalized the FDI policy, allowing higher levels of foreign investment in various sectors. For example, 100% FDI is allowed in many sectors under the automatic route.
- ‘Make in India’ Initiative (2014): This initiative aims to transform India into a global manufacturing hub by attracting FDI in the manufacturing sector.
- Production Linked Incentive (PLI) Scheme (2020): The PLI scheme provides financial incentives to companies that increase their domestic production, thereby attracting FDI in key sectors like electronics, pharmaceuticals, and automobiles.
- National Single Window Clearance System: This system simplifies the process of obtaining approvals and clearances for FDI projects, reducing bureaucratic hurdles.
- Relaxation of Local Sourcing Norms: The government has relaxed local sourcing norms for certain sectors to encourage FDI.
- FDI in Defence Sector: Increased the FDI limit in the defence sector to promote indigenous manufacturing and attract technology transfer.
According to data from the Department for Promotion of Industry and Internal Trade (DPIIT), India received USD 84.835 billion in FDI during the financial year 2022-23, a decline from USD 87.55 billion in 2021-22, but still a significant inflow. (Data as of knowledge cutoff - November 2023)
Conclusion
In conclusion, while both FDI and FPI play a role in economic development, FDI is undeniably preferred due to its stability, long-term commitment, technology transfer, and positive impact on employment and the balance of payments. The Indian government’s proactive policies, such as the ‘Make in India’ initiative and the PLI scheme, demonstrate its commitment to attracting FDI and fostering sustainable economic growth. Continued efforts to streamline regulations, improve infrastructure, and enhance the ease of doing business will be crucial to further attract FDI and realize its full potential for India’s economic transformation.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.