Reality Behind Falling Net FDI

Why in News?

India’s net foreign direct investment (FDI) has declined drastically in recent years; the critics see the weak net flows as a sign of weakness.

What about FDI & its types?

•  FDI – It refers to an ownership stake in a foreign company or project made by an investor, company, or government from another country.
• FDI is generally used to describe a business decision to acquire a substantial stake in a foreign business or to buy it outright to expand operations to a new region.
• FDI is often viewed as a uniform, long-term commitment that brings technology and management skills to the host country.
• 3 types of FDI – FDI can fall into three different investor classes, each with distinct capabilities, strategies, and exit timelines.
• Real FDI (RFDI) – It generally represents long-term commitments, which consist of traditional multinational enterprises with the technology, brands, and capabilities to establish production and services.
• Financial Investors – This category comprises financial investors, including private equity funds, venture capital firms, sovereign wealth funds, and asset managers with a main goal of capital growth and planned exits.
• Diaspora & SPVs – This category includes diaspora investments and special purpose vehicles (SPVs).
• These involve capital raised abroad and funneled through offshore financial centres, sometimes including the roundtripping of Indian funds.

What are the key trends of FDI flows in India?

• Debate on Net FDI – Critics argue that weak net flows show India’s vulnerability.
• In contrast, the Chief Economic Adviser points to the large inflows and rising manufacturing FDI as strength.
• He links weak net flows mainly to profit repatriation and outward investment by Indian companies. 
• Overlooked Issue – Both sides focus too much on overall numbers.
• What they miss is the changing composition of international capital and the Balance of Payments (BoP) mechanisms that govern inflows and outflows.
• Net FDI – For BoP, the net FDI is calculated as the difference between inflows and outflows after adjusting for the repatriation of capital.
• Net FDI Trends – From the peak of $44.0 billion in 2020-21, net FDI fell to less than $1 billion in 2024-25.
• It recovered to $7.6 billion in 2025-26. The corresponding gross inflow was $94.6 billion.
• Policy Evolution – India’s liberal FDI policy, introduced in 1991, initially emphasised technology acquisition, export promotion, and foreign exchange conservation.
• Over time, policy increasingly prioritised attracting larger inflows, while concerns regarding future external payment obligations and investment quality receded.
• Composition of Inflows – Data on remittance-level FDI from the past four years, from 2022-23 to 2025-26 up to December, show that
  • Real FDI (RFDI) - 41.9%
  • Financial investors - 40.5%
  • Diaspora & SPVs - 17.6%
• Financial Investor Exits – The business model of financial investors suggests future exits that result in large-scale capital repatriations.
• Example – In 2025, Singapore’s Temasek exited Schneider Electric India Ltd., earning $6.4 billion from a $637 million investment made in 2020. 
• Total recorded divestment in CY 2025 was $52 billion, with 45 major foreign private equity and venture capital exits accounting for $29 billion in outflows.
• Manufacturing FDI Decline – Based on an analysis of effective inflows, FDI in India’s manufacturing sector has declined across three consecutive four-year periods.
• Most notably, RFDI into manufacturing accounted for only 10.6% of total effective inflows.
• Not Fresh Capital – The Gross FDI figures is the ixing of new capital injections with corporate accounting changes, such as
  • Intra-group ownership reorganisations,
  • Mergers, share swaps,
  • Conversion of earlier non-equity instruments such as external commercial borrowings (ecbs) and convertible debentures.
• In such cases, no new money enters India — it’s just a change in capital structure.
• Scale of the Issue – Approximately $40 billion of the $560 billion in equity inflows to India from 2014-15 to 2025-26 (up to December) fall into this category.
• Large transactions, such as Bosch and Meesho Technologies, can distort annual inflow and sectoral trends.

What about the disinvestment & OFDI trends?

• Disinvestment Drives Decline – The common claim that profit repatriation depresses net FDI is misleading.
• Under BoP conventions, profits sent as dividends are recorded as investment income in the current account.
• They increase the current account deficit (CAD) but do not change the reported net FDI flows.
• Instead, the primary reason for weak net FDI is disinvestment and capital repatriation, which appear in the financial account.
• Outward FDI (OFDI) – India’s outward investments need closer scrutiny rather than being attributed solely to corporate maturity.
• From 2023–24 to 2025–26, India invested $65 billion abroad, of this 45% went into financial, insurance, and business services (FIB).
• Singapore & UAE accounted for 27% and 11% became top destinations. 
• These funds mostly go to holding companies and SPVs rather than directly to operational entities.
• Example – Tata Motors’ subsidiary, TML Commercial Vehicles, invested $405 million in a Singapore FIB entity to acquire Italy’s IVECO Group.
• GIFT City Flows – Capital movements through GIFT City add complexity.
• OFDI to the City increased from $246 million in 2023-24 to $1.18 billion in 2025-26.
• Total OFDI & inward FDI through it until 2025-26 reached $2.35 billion and $1.40 billion, respectively, highlighting the growing two-way flows.
• Implications – OFDI can represent both genuine corporate expansion and the return of capital that fled.
• But it can also mean capital recycling, where funds leave India only to return via different jurisdictions.
• Therefore, increasing OFDI does not always indicate corporate maturity; it may also indicate resource-seeking or roundtripping of capital.

What are the trends associated with the outflow channels?

• FDI Inflows – Between 2022–23 and 2025–26, India received
  • Gross inward equity FDI - $317.8 billion
  • Excluding reinvested earnings - $230.6 billion
• Capital Account Outflows – Disinvestment and capital repatriation (capital account) totalled $178.9 billion.
• It is primarily driven by financial investors through secondary and strategic sales, IPO exits and share buybacks.
• This includes
  • “Offers for sale” by foreign promoters such as hyundai and LG.
  • Sell-offs by RFDI investors, such as wistron which sold off to the tatas.
• Current Account Outflows 
• Dividend Remittances – Amounted to $118.9 billion in profits paid out by MNE subsidiaries and affiliates, excluding reinvested earnings.
• IPR payments (royalties) – Totalled $46.6 billion; these payments are made by MNE subsidiaries and affiliates for intellectual property (assuming they account for 75% of total IPR payments), can substitute dividends.
• Technical/Service/Consultancy Payments – $250 billion was transferred, it is difficult to divide this amount between RFDI and domestic companies.
• Net Effect – Even excluding OFDI and technical service payments, outflows due to disinvestment, dividends, and IPR payments reached $344.4 billion.
• Trend Over Time – Therefore, for every dollar of fresh inflow (excluding reinvested earnings), approximately $1.50 has flown out; this situation has worsened over the past 12 years.
• The corresponding outflow per dollar entered was 56 cents from 2014-15 to 2017-18, rising to 70 cents from 2018-19 to 2021-22, before reaching the current high.

What lies ahead?

• The above narrative shows how an incomplete view of FDI prevails in public discourse.
• Different types of investors, entry methods, and exit strategies impact technology transfer, industrial growth, and external sustainability.
• The reporting of global FDI flows adds an additional layer of problems.
• Understanding these nuances is crucial for evaluating FDI beyond headline numbers.

To take mains test, click here  

Reference

The Hindu | The reality behind falling net FDI