Ankit Rahangdale is a seasoned finance professional with a distinguished background as a Chartered Accountant. Currently, he leads the Finance Department at Pice. With over five years of invaluable experience in the banking and finance sector, honing his expertise through esteemed institutions such as ICICI Bank and Standard Chartered Bank.
23 Jun 25
14 mins
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Impact of GST on Foreign Direct Investment in India
FDI is a long-term investment strategy that fuels India’s economic growth through capital, technology, and expertise.
India allows FDI through Automatic and Government Routes, enabling smoother entry in most sectors.
Horizontal, vertical, conglomerate, and platform FDI offer diverse avenues for global companies to invest in India.
While FDI brings job creation, technology transfer, and infrastructure development, it may also cause local market displacement and economic dependence.
Major global players like Amazon, Suzuki, and Apple exemplify successful FDI models, reinforcing India’s status as a global investment destination.
Foreign Direct Investment (FDI) has been a cornerstone of India's economic policy since the liberalization reforms of 1991. It represents a crucial channel for attracting capital, technology, and expertise from abroad, significantly contributing to the nation's growth trajectory. FDI is more than just a financial inflow; it signifies a long-term commitment by foreign entities seeking substantial interest and control in Indian enterprises.
This form of investment plays a pivotal role in bridging the gap between domestic savings and investment needs, fostering innovation, enhancing infrastructure, and integrating India more deeply into the global economy. Knowing FDI's nuances, its meaning, impact, routes, benefits, and drawbacks, is essential to appreciating its complex role in shaping modern India.
What is Foreign Direct Investment
Foreign Direct Investment (FDI) is an investment by a foreign firm or person in a business within another nation. This can mean taking control of a significant percentage of a firm, creating new business operations, or reinvesting profits from overseas operations. FDI is a critical component of the world economy, for it promotes the transfer of capital, technology, and skills across nations to the mutual advantage of the investor and the host nation.
Importance of Foreign Direct Investment
Foreign Direct Investment (FDI) is significant for the economic growth of the host and investing country. It brings a range of advantages, from employment opportunities to technology transfer, which have long-term beneficial effects on the economy.
Economic Growth and Job Creation:
One of the major advantages of FDI is that it stimulates economic growth. Foreign firms that invest in a nation create new firms, set up industries, and provide job opportunities. All this capital inflow and provision of resources bring up the nation's Gross Domestic Product (GDP) level and lower its unemployment rate.
For instance, foreign multinational corporations usually establish manufacturing plants or establishments, employing people in manufacturing sectors and bringing economic development.
Technology and Knowledge Transfer:
FDI facilitates the transfer of high technology, management techniques, and technical expertise from developed nations to developing countries. Foreign investors tend to introduce new technologies that increase productivity, quality, and overall efficiency of domestic industries for a committed investment. This, in turn, enhances the competitive advantage of the home market and enables businesses in the host country to modernise and grow.
Infrastructure Development:
Foreign investments generally improve infrastructure and create a dynamic business environment. Moreover, investors may develop transportation, communication, and utility systems that benefit the host nation in the long run. For example, multinational enterprises tend to create more efficient supply chains and delivery networks, enhancing overall regional logistics.
Over time, India's FDI policy has changed, with the central government repeatedly bringing in reforms to attract foreign investments. The policy is meant to increase economic growth, employment, and technology and expertise transfer. Currently, India permits FDI in most industries, with specific rules governing the defence, retail, and media sectors.
The government has liberalised its policy towards FDI by allowing 100% foreign investment in industries such as technology, automobiles, and services under the automatic route, which does not need prior approval. However, there are some sectors, such as defence and banking, where FDI is subject to limits and government approval.
Besides the automatic route, FDI can also be made under the government route, where the Indian government's prior approval is required. The government has eased restrictions progressively to encourage foreign investments, particularly in sectors of strategic importance for infrastructure development, like energy, railways, and civil aviation.
Using tax concessions, streamlined processes, and industry-targeted reforms, India has emerged as one of the most competitive destinations for global investors. Its strategic position, market size, and expanding consumer market further enhance the attractiveness of Indian businesses as a site for FDI.
Types of Foreign Direct Investment
Different types of Foreign Direct Investment exist with separate beneficial effects that benefit investors and countries hosting investment operations. Two main categories exist for FDI, which include:
Horizontal FDI: Companies conduct Horizontal FDI by investing in businesses that operate in another country to manufacture products or deliver services of an equivalent nature to their operations. Spain-based retailer Zara invested in Fab India, which operates as an apparel company in India. The primary objective of horizontal FDI consists of expanding the business with specific product suites through foreign market entry and utilising products currently offered in the investor's product range.
Vertical FDI: Vertical FDI describes business investments which involve supply chain enterprises. Domestic companies may choose to invest in a business located before or after its supplier chain. Moreover, a firm conducting backward vertical FDI invests money into suppliers such as Nescafe, adding coffee plantations across Brazil. A company implements forward vertical Foreign Direct Investment through investments directed toward customers or distributors, such as Indian coffee producers who acquire ownership of French grocery stores.
Conglomerate FDI: Businesses participating in conglomerate FDI choose to bring capital into separate, unrelated business sectors. Walmart demonstrates this strategy with specific product suites through its investment in Tata Motors, as the American retailer extends into Indian automobile manufacturing. This represents diversification across different business industries.
Platform FDI: A company follows Platform FDI by establishing operations in one territory and exporting its products worldwide. Chanel's production facility in the USA presents a clear example of platform FDI because it creates perfumes that are exported worldwide.
FDI Routes in India
In India, Foreign Direct Investment (FDI) can be routed through two prominent modes: the Automatic Route and the Government Route.
Automatic Route: Through the Automatic Route, foreign investors can invest in Indian firms without approval from the government or the Reserve Bank of India (RBI). This route is available for nearly all sectors, including technology, manufacturing, and services. It simplifies things and allows a faster inflow of foreign funds. For example, behemoths like Google and Amazon have invested in the tech sector in India through this route.
Government Route: The Government Route requires foreign investors to obtain approval from the Indian government before investing. This route is typically reserved for national security-sensitive or strategic industries such as defence, media, and aviation. The approval process is designed to guarantee that the investment is in line with India's economic and security interests.
During the past decade, FDI inflows into India have witnessed a steep rise, testifying to the nation's increasing attractiveness as an investment hub. India remained one of the top FDI destinations in the world between 2011 and 2021, drawing investments from various industries, such as technology, manufacturing, services, and retail.
In 2020-21, unaffected by the COVID-19 pandemic's challenges, India recorded an all-time high FDI inflow of over $81 billion, with critical sectors such as digital services, e-commerce, and pharmaceuticals attracting heavy investments. All this is said to be a result of Narendra Modi's strong economic reforms, digitalisation, and government programs such as "Make in India" and "Atmanirbhar Bharat."
FDI Allowed Sectors in India
Foreign Direct Investment (FDI) in India is permitted in most sectors, subject to some restrictions for a few industries. Major sectors open to 100% FDI are technology, pharmaceuticals, automobile production, and services. Industries such as retail (single-brand), e-commerce, and construction also welcome high foreign investment.
The defence, broadcasting, and media industries implement restrictions through which the government permits FDI beyond their particular authorised thresholds. The government allows foreign investment in the agricultural sector, but this authorisation requires set conditions, while the multi-brand retail sector remains restricted unless previously specified guidelines are followed.
The primary goal of the government is to modify its policies to attract more foreign capital investments while avoiding compromises to national priorities.
Sectors where FDI is not allowed in India
India has specific areas in which FDI remains restricted except by approved government authorisations. Some industrial sectors in India cannot accept FDI due to national safety prerequisites and strategic industry requirements or existing regulations. These are sectors like:
Retail (Multi-brand): The entry of foreign direct investors into multiple brand retail remains limited only to specific scenarios authorised by the government.
Defence: FDI in defence is limited to 49% through the automatic route, with greater investments needing government approval.
Agriculture: Foreign investment in agricultural land is otherwise prohibited except in cases of plantation crops.
Lottery, Gambling, and Betting: FDI in these industries is prohibited.
India has seen large foreign investments across sectors in recent years, which indicates its emerging status as a global economic powerhouse. Some of the most prominent foreign investments creating inclusive growth include Walmart and Amazon in the e-commerce and retail sectors. Amazon gained dominance in Indian e-commerce through huge investment, while Walmart secured its position in Indian retail by acquiring Flipkart in 2018.
The automobile industry witnessed success from Suzuki after it demonstrated a long-lasting dedication to India through establishing manufacturing facilities to develop the Indian car industry. Also, Hyundai Motor and Toyota heavily invested in the Indian market to expand their production.
Even Apple has escalated its investments within India by undertaking manufacturing and assembling activities in the country in alliance with domestic players such as Wistron and Foxconn.
In the technological industry, there have been enormous investments by Microsoft and Google in digital infrastructure, technological expertise of individuals and cloud services, driving India's digital revolution. These investments exemplify the deepening trust and confidence in the market potential across various industries.
Foreign Direct Investment Example
One notable example of foreign direct investment (FDI) in India is Suzuki's investment in the country's automobile sector. In 1982, Suzuki, a Japanese carmaker, entered the Indian market through a joint venture with Maruti Udyog, an Indian company. This investment resulted in the introduction of advanced automotive technology, the creation of jobs, and the establishment of manufacturing facilities in India.
Over time, Suzuki increased its ownership of Maruti until it held a majority stake. As the leading automobile manufacturer in India today, Maruti Suzuki is a shining example of successful foreign direct investment creating inclusive growth because of its investment, which has significantly contributed to the growth of the nation's auto industry.
Advantages of Foreign Direct Investment
FDI is essential in promoting the economic growth and competitiveness of a country.
1. Economic Growth and Job Creation: FDI helps to augment a nation's economic growth. It infuses capital, which is utilised to open new businesses, increase the size of existing ones, and increase production capacity. This creates employment opportunities across industries and reduces unemployment. For example, when multinationals invest in India, they open factories and retail shops, creating thousands of jobs of varying skill levels.
2. Technology Transfer and Skill Development: Foreign investment is one of the primary advantages of FDI, bringing in advanced technology and managerial skills from foreign investors to local companies. This assists in increasing productivity, enhancing the quality of products, and providing new production techniques. Foreign investment in industries such as manufacturing and IT offers training and development opportunities to local staff, leading to skill development.
3. Infrastructure Development: FDI creates infrastructure like roads, ports, power stations, and telecommunication networks. Foreign investors tend to construct or enhance crucial infrastructure to serve their operations, which indirectly benefits the local populace and other industries. For instance, foreign investment within the Indian infrastructure industry has resulted in enhanced transportation and logistical systems.
4. Greater Export Opportunities: Foreign investment tends to result in a greater capacity for exports by connecting domestic firms to international supply chains. This increase in export markets boosts the nation's trade balance and the nation's position in the world economy.
Although FDI has some advantages, it has some disadvantages as well, which affect the host country's economy and local enterprises.
1. Loss of Control: When foreign firms make investments in domestic firms, they will normally gain a high degree of control over management, decision-making, and strategy. This may lead to loss of control for domestic firms, particularly if they have majority stakes held by foreign investors. Such dominance may also influence decisions that serve foreign investors' interests ahead of local demands.
2. Profit Repatriation: One of the primary drawbacks of FDI is the repatriation of profits. Foreign investors typically remit a large share of their earnings to their home countries, cutting down on the long-term dividends that might be invested in the host economy. This reduces the local growth-positive impact and can cause capital outflow.
3. Market Displacement: FDI can push domestic firms away from the local market, particularly where foreign corporations possess more finance and technology strengths. Small and medium-sized enterprises (SMEs) can no longer compete against multinational companies that are adequately financed, diminishing the diversity in markets and maybe leading to loss of employment.
4. Economic Dependence: Overdependence on FDI may expose an economy to the vagaries of global economic cycles. When foreign investors withdraw or reduce their investments during an economic recession, it can negatively affect the economic stability and growth potential of the host country.
Conclusion
Overall, Foreign Direct Investment (FDI) is an important factor in India's economic growth through the promotion of job generation, technology transfer, and infrastructure development. Though the benefits are immense, such as economic growth and market size increase, there are also disadvantages like possible displacement of markets and economic reliance.
With India's positive policies, FDI is still shaping its destiny, offering opportunities and risks. An understanding of such dynamics is key to harnessing FDI to serve the national long-term economic interests.
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FAQs
What is Foreign Direct Investment (FDI)?
FDI refers to an investment made by a foreign entity—individual or company—into the business interests of another country. It often involves acquiring a significant ownership stake, establishing new operations, or reinvesting earnings in the host country. Unlike portfolio investment, FDI implies long-term involvement and control in a company. It is a key driver of economic integration and globalization.
Why is FDI important for India’s economy?
FDI plays a critical role in bridging the gap between domestic savings and investment needs. It brings in foreign capital, modern technology, advanced managerial practices, and employment opportunities. Sectors like manufacturing, services, and infrastructure benefit significantly. FDI also strengthens India’s global trade links and economic resilience.
What are the routes through which FDI enters India?
India offers two main routes for FDI: the Automatic Route and the Government Route. Under the Automatic Route, foreign investors don’t need prior approval and can invest directly in permitted sectors. The Government Route requires clearance for sectors that are sensitive, like defence and media. The ease of these routes has been improved over time to attract more investors.
What are the advantages of FDI for the host country?
FDI boosts economic growth, creates jobs, and enhances productivity through the transfer of technology and expertise. It supports infrastructure development, increases export potential, and modernizes industries. Additionally, it helps local companies integrate into global value chains, fostering innovation and global competitiveness.
Are there any disadvantages or risks of FDI?
Yes, FDI can lead to loss of domestic control, especially if foreign investors hold majority stakes. Profit repatriation to the investor’s home country may limit reinvestment locally. Small businesses may face market displacement due to strong competition. Overreliance on FDI can also make a country vulnerable to global economic shifts.
Ankit Rahangdale is a seasoned finance professional with a distinguished background as a Chartered Accountant. Currently, he leads the Finance Department at Pice. With over five years of invaluable experience in the banking and finance sector, honing his expertise through esteemed institutions such as ICICI Bank and Standard Chartered Bank.
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