India needs lasting reforms to attract foreign capital not stopgaps

ASIA MACRO INSIGHTS WRITTEN BY India needs lasting reforms to attract foreign Alicia GARCIA HERRERO capital, not stopgaps Tel. India’s biggest economic challenge today is creating enough good jobs. Around 10-12 million young people join the labour This is a reprint. This article was initially force every year, but manufacturing — the sector that should published by Business Standard. create jobs at this scale — has remained stuck at 15-17 per cent of gross domestic product (GDP) for the past two decades. Expanding manufacturing will require higher investment, and domestic savings alone will not be enough to finance it. India needs more foreign direct investment (FDI) to bring in capital, standard.com/opinion/columns/india- technology as well as jobs. The recently concluded India- needs-lasting-reforms-to-attract-foreign- European Union free trade agreement (FTA) offers an capital-not-stopgaps- _1.html opportunity to do this. The question is whether India will take it.

The FDI numbers are sobering. While media discourse mostly focuses on the gross numbers, India’s FDI inflows as a share of GDP have fallen to less than 1 per cent, far below the 5.7 per cent average for Asean economies such as Vietnam and Malaysia. These countries have emerged as the biggest beneficiaries of the China+1 shift, while India has largely missed out despite being a bigger economy. Moreover, much of the FDI that India does attract goes into services rather than manufacturing, thereby limiting its impact on job creation.

To attract substantial manufacturing FDI, policymakers now have to persuade global firms to choose India for the next phase of their expansion. That will not be easy. It requires addressing the factors that have made India a less attractive investment destination over the past decade.

One important factor has been the growing uncertainty around investment protection. Between 2016 and 2024, India terminated bilateral investment treaties (BITs) with 77 countries, including 22 EU member states, and replaced them with the much narrower 2015 Model BIT. New investments from these countries no longer enjoy the safeguards that BITs typically provide against arbitrary state action, discriminatory treatment, uncompensated expropriation and unpredictable dispute resolution. As a result, Discover more on our Website foreign investors have less certainty today about investing in India. (continued on next page)

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In addition, India continues to impose average import tariffs of nearly 16 per cent, well above those in Asean economies. Recent bilateral FTAs lower tariffs for a few selected partners, but they are a second-best substitute for the broader trade liberalisation that globally integrated manufacturers need. The growing use of quality control orders (QCOs) has further raised costs by restricting access to imported inputs. India’s decision to stay out of the World Trade Organization’s Investment Facilitation for Development Agreement (IFDA) reinforces this perception, signalling caution at a time when global investors are looking for openness. These frictions matter when firms decide where to locate their next factory.

Investment protection deserves fresh thinking. For instance, commercial disputes are contractual matters. If a foreign investor and its Indian partner agree to resolve them through arbitration in Singapore or any other internationally recognised forum, the government should not prevent them from doing so. Giving contracting parties the freedom to choose a credible dispute resolution mechanism would send a strong signal that India is serious about attracting long-term investment.

This is where the recently concluded India-EU FTA becomes important. The EU is the world’s largest source of outward investment, accounting for around 40 per cent of global FDI stock, and is already one of India’s largest investors. The FTA gives European firms a…