Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Key Phrases: Uncertainty, Accommodative Monetary Policy, Domestic Investment, Capacity Utilisation, Consumption, Inflation worries, Investment in Infrastructure, Private Sector, World Competitiveness Index 2021.

Why in News?

• Given the uncertain geopolitical situation which has led to supply chain disruptions and inflation, investors will be on ‘wait and watch’ mode this year.

Context:

• The Budget this year was announced amidst optimism which was followed by an accommodative stance by the RBI. The Finance Minister had flagged the concern on investment which was however supposed to change track in FY23 with an initial nudge being given by the government through higher capex.
• But things have changed with the war erupting later in February and there being few signs of a solution in the near future. Things do not look the same from an investment perspective. There have been simultaneously other monetary action developments in the West which have made foreign investors rethink their options.
• After getting in around $80 billion as FDI in FY21, it was largely expected to be replicated in subsequent years. For the first three quarters of FY22 there have been flows of around $60 billion of which equity flows are around $43 billion. This was slightly lower than that in the previous year.

FDI Investment in India:

• According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflow in India stood at US$ 560.78 billion between April 2000 and September 2021, indicating that the government's efforts to improve ease of doing business and relaxing FDI norms have yielded results.
• Data between April-September 2021 indicates that the computer software and hardware industry attracted the highest FDI equity inflow of US$ 7.12 billion, followed by the automobile sector at US$ 4.93 billion, services sector at US$ 3.15 billion, trading sector at US$ 2 billion, metallurgical industries at US$ 1.3 billion, and construction activities at US$ 1.22 billion.
• Between April-September 2021, India recorded the highest FDI equity inflow from Singapore (US$ 8 billion), followed by the US (US$ 4.63 billion), Mauritius (US$ 4.33 billion), the Cayman Islands (US$ 2.15 billion), Netherlands (US$ 2.14 billion), the UK (US$ 1.15 billion) and Japan (US$ 804 million).

Effect of War Clouds on Investment:

• FDI has been a useful source of funding for investment in the country as it supplements domestic efforts. Here there are two things happening.
  • The first is that the West has started raising rates ostensibly on the back of rapid economic growth (which would slow down due to the war), and this has opened new opportunities for investors.
  • The second is that the war and the resulting uncertainty which has been flagged through sanctions can make investors cherry pick their destinations.
• The first can affect the decisions to go out to the emerging markets or stay invested within their countries. The second can make investors tend towards being cautious and prefer to remain within the closed group of western nations.
• The same also applies for portfolio investment where typically future returns based on valuations influence decisions. But it has been seen that FPIs have been whimsical in the equity market this year and tended towards withdrawal which can be attributed again to the uncertainty in the geopolitical situation. For debt the interest rate differential will be the clinching factor and as long as we have a very accommodative monetary policy, these dynamics may not be favourable.

Investment Scenario in India:

• Currently, the domestic investment scene is a mixed bag. On the manufacturing side, as per RBI data capacity utilisation rates appear to be increasing and had touched 72.4 per cent by December. Manufacturing seemed to be on the threshold of sustained improvement, which was expected to lead to higher investment as demand picked up. The crux is on how households behave in these uncertain times as increase in consumption is a prerequisite for better capacity utilisation which in turn leads to higher demand for investment.
• There is now uncertainty over consumption mainly due to the sharp increase in inflation which is close to 7 per cent and is unlikely to return to the sub-5 per cent levels. Prices of all commodities have gone up. Food prices have gone up with pressures arising on the edible oil front as Russia and Ukraine are major suppliers of sunflower oil and disruption has affected prospects for all oils.
• Wheat prices are up even with a very good crop as export opportunities present attractive options for farmers/traders. Fuel prices remain high and while it does look like that the equilibrium would be around $110/barrel for crude oil, the absence of any measure on the government’s part to lower taxes means that prices will remain high.

Inflation Worries on Investment:

• Manufactured products had borne the brunt of the first round of inflation of 2021 for the first three quarters of the year and since September have been passing on the higher input costs to consumers. The new round of global commodity price boom will definitely invoke another round of price rise during the course of the year as companies work towards protecting their profit margins.
• This is not good news for consumption because with broad-based higher inflation there will be a tendency for more money to be spent on necessities which include food items and daily products and services, leaving less money for discretionary consumption. This in turn will affect overall capacity utilisation and hence investment. Unless things change quickly in the next couple of months, such a scenario is bound to come in the way of investment.
• The other area driving investment in infrastructure. The Centre has put in a lot of effort in enhancing the outlay for capex to ₹7.5 lakh crore for the year. This can contribute but not drive investment as the private sector has the most important role to play. There were expectations that this part of the puzzle would fall in place this year. In fact, given that the banks had put behind the NPA issue after all the efforts have been put in at resolution, they have become more open to long-term funding. This could have been a turning point.
• But there are two forces at play.
  • The first is that given the disruption in global supply chains and higher prices, the entry of private players in the infra space may take a backseat till there is more clarity.
  • Second, interest costs have already started moving up, which is evident in the bond market to begin with. Banks too have been recalibrating their lending rates which in turn can be a subtle entry barrier for the private sector.

Way Forward:

• India ranked 43rd on the Institute for Management Development’s (IMD) annual World Competitiveness Index 2021. According to the IMD, India's developments in government efficiency are primarily due to relatively stable public finances (despite COVID-19-induced challenges), and optimistic sentiments among Indian business stakeholders with respect to the funding and subsidies offered by the government to private firms.
• Therefore the entire dynamics of investment has changed in the last two months. To being with it was felt that the war cannot possibly last for a long period of time. The imposition of sanctions has not quite reduced the hostility but disrupted supply chains and prices significantly which has affected all countries in this globalised world. The exports scenario no longer looks that attractive and with surging inflation there is potential to push back consumption, investment and growth.
• Forecasts are already lower than they were in February. Even a resolution of the war by June will still keep business jittery in this vale of uncertainty. It will be another year of wait-and-watch for investment.

Source: The Hindu BL

Mains Question:

Q. Discuss the effects of war cloud on the foreign investment in India. What steps should India undertake to bring positive sentiments related to investment in India? Critically examine.