Growth and Quality of FDI: Are all FDI Equal?

calendar09 Jan, 2020
timeReading Time: 4 Minutes

India is classified as a newly industrialized country, and one of the G-20 major economies, with an average growth rate of approximately 6% over the last two decades. It is an essential vehicle of technology transfer from developed countries to developing countries. Its positive interaction with human capital enhances the contribution of FDI to economic growth. Higher the level of human capital in the host country, higher the effect of FDI on the country’s economic growth.

Hence, to overcome the saving-investment gap, many countries have acquired the method of Foreign Direct Investment, which will limit the level of domestic investment and encourage foreign investment. It helps in filling such a gap by bringing foreign investment into the country as well as bringing difference in management, technology and entrepreneurship skills. It acts as a valuable source of technology and foster linkages with local firms and companies to jump start the economy.

What is Foreign Direct Investment?

Foreign Direct Investment is an investment made by a company or firm in one country into business interests located in another foreign nation. Generally, FDI takes place when an investor settles its business operations or acquire international business assets in another foreign company.

How is the Growth of a Country and Quality of FDI interrelated?

The rate of Foreign Direct Investment is different for different sectors in India; however, there lies a relationship between FDI and growth. The term “quality of FDI” means the ‘effect of a unit of FDI’ on economic growth. But it becomes difficult to distinguish the quality of Foreign Direct Investment in different sectors with the growth in a particular country.

To summarise our findings, the growth effects of FDI[1]increases when we account for characteristics which might affect the quality of Foreign Direct Investment.

“Quality FDI” can be differentiated in many ways which are listed below:

  • Effects of FDI differ by Sector and Industry;
  • FDI based on objective qualitative industry characteristics including the average skill intensity;
  •  FDI based on the subjective preferences expressed by the receiving countries.

What are the advantages of FDI in India?

FDI has various key advantages ranging from economic growth of the nation to provide youth employment.

Promotion of Investment in key areas

Allowing FDI in a country promotes investment in key areas such as infrastructure development.

Increase in Capital flow

FDI helps in promoting more capital inflow into the country, which will speed the economic growth of the country.

Increase in exports

The exports of many under underdeveloped and developing countries have increased with the help of FDI with the creation of economic zones and the promotion of 100% export oriented units.

Employment Opportunities

With the advent of Foreign Direct Investment in developing countries, there is a significant increase in employment opportunities in the nation.

Promotion of Financial Services

With Foreign Direct investment in a country, the capital market of a country has strengthened through activities such as merchant banking and portfolio investment.

Exchange Rate Stability

The Reserve Bank of India is continuously striving to maintain the exchange rate in our country through its exchange control measures. With the inflow of more FDI in a country, RBI now has a very complacent foreign exchange reserve position.

What are the Routes through which India gets FDI?

There are mainly two routes through which India get FDI –

Automatic Route

In the automatic route, Indian Companies and Non-Resident Indian do not require RBI approval for FDI.

Government Route

In case, any sector wants to get FDI; then it requires prior government approval. The company has to apply through the Foreign Investment Facilitation Portal. The application is then accelerated to the respective ministry. The particular ministry will approve or reject the application after consultation with the Department for Promotion of Industry and Internal Trade, Ministry of commerce.

What are the Sectors which come under the “100 per cent Automatic Route” Category?

  • Agriculture & Animal Husbandry,
  • Air-Transport Services (non-scheduled and other services under the civil aviation sector)
  • Airports (Brownfield + Greenfield)
  •  ARCs (Asset Reconstruction Companies)
  • Automobiles such as cars and motorbikes.
  • Biotechnology (Greenfield)
  • Broadcast Content Services and Broadcasting Carriage Services
  •  Capital Goods
  •  Cash & Carry Wholesale Trading Chemicals
  • Coal & Lignite
  •  Construction Development
  •  Hospital Construction
  • Credit Information Companies
  • Duty-Free Shops
  • E-commerce Activities
  • Electronic System
  •  Food Processing Units
  • Jewellery and gems
  • Healthcare Sector
  • Industrial Parks such as IT and Business Parks
  • IT & BPM(Business Processing Management)
  •  Leather Industry
  • Manufacturing Sector
  •  Mining & Exploration of metals & non-metal ores
  •  Other Financial Services
  • Services under Civil Aviation Service (For example – Maintenance & Repair Organizations)
  • Petroleum & Natural gas Sector
  •  Pharmaceutical Sector
  • Plantation sector
  • Ports & Shipping
  • Railway Infrastructure
  •  Renewable Energy
  • Roads & Highways
  • Single Brand Retail Trading
  • Textiles & Garments
  • Thermal Power
  • Hospitality and Tourism Sector
  • White Label ATM Operations.

Why is India an Attractive Destination for FDI?

FDI has hugely developed in the whole world. It has made development of infrastructure possible in the country in order to provide a better living standard. Because of the role of multinational company, it has coincided with the rise in FDI, which signifies an increasing share of the foreign ownership in those economies.

With time, India has paved itself as one of the leading economies in the world. Besides this, India is considered as the world’s second fastest emerging economy and is consequently a very profitable and attractive market for FDI. The FDI stock in India has improved when the economic reforms happened radically from less than $2 billion in 1991 to more than $45 billion in 2005. It is believed that there are two major factors that have augmented the inflow of FDI into India. The first one is the structural reason like the infrastructure quality, geographical and market size and cultural consensus with the major sources of capital. The second one is the policy factors like investment incentives, rate of tax and performance requirements.

What are the Sectors under which FDI is prohibited?

There are some sectors and industries under which FDI is strictly prohibited:

  • Atomic Energy Generation
  • Any Gambling or Betting businesses
  • Lotteries (online, private, government, etc.)
  • Investment in Chit Funds
  • Nidhi Company
  • Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc.)
  • Housing and Real Estate (except townships, commercial projects, etc.)
  • Trading in TDR’s
  • Cigars, Cigarettes, or any related tobacco industries


The quality of FDI is associated with positive and economically significant growth effects which cannot be overlooked. The relation between the growth and the quality of FDI is stronger for industries with higher skill requirements and industries more reliant on external capital. Understanding the effect of FDI on economic growth is quite important as one must be able to figure out the sector he or she wants to invest in.

Read our article:Alternative Investment Fund Registration

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