Tends of Foreign Direct Investment

Despite a significant 80% reduction in global private equity and venture capital (PE-VC) investments in 2022, particularly noticeable in the US, UK, and China, India's reduction was only 50% compared to the previous year. Over the last decade, there has been a consistent rise in PE-VC investments in India, despite India ranking 18th globally in terms of PE-VC attractiveness.  The backbone of modern innovation—seen in firms such as Apple, Google, OpenAI, Meta, and even the internet—has largely been supported by PE and VC funds. These funds offer crucial growth capital for emerging technologies and play a pivotal role in industrial evolution. In the push towards industrialization, it is imperative to increase the technology and capital inputs of an economy. This increase is made possible by these alternate capital sources - VC funding. As nations progress, PE is vital for transitioning from labor-intensive to knowledge and innovation-driven economies. Interestingly, PE-VC investment in India has more than doubled in the past decade compared to the previous one.
This discussion delves into the trends of Foreign Direct Investment (FDI, specifically PE-VC) in India and foreign investors' responses to understand if India is on the trajectory towards becoming an advanced industrial economy. The essay first examines PE-VC inflows, growth, sectors benefiting from these funds, and compares them with other emerging markets. It then explores the source countries of these investments, the implications of technology transfer, and India's regulatory frameworks. Furthermore, it assesses the impact of foreign direct investment (FDI) on industrialization, workforce skills, and broader social issues like income inequality and urbanization.

Investment Trends

Bain & Company's India Private Equity Report 2023 highlights that India attracted over $60 billion in PE and VC investments for the third consecutive year, despite a global downturn. The country's share of these investments in the Asia-Pacific region has strengthened from about 15% to approximately 20%, demonstrating its growing appeal compared to other emerging markets within the region. India has ranked only third in the number of Unicorns (companies worth over a billion dollars) as of 2023, behind the US and China.
With these increasing investments, noteworthy exits in traditional sectors of India's economy have been observed. Initial Public Offerings (IPOs) have been a notable point of exit for investors, hosting corporations such as Rainbow Hospitals that outperformed the market index. Other exit strategies have included secondary sales. The opportunities for foreign investors over the past decade have been fueled by large consumption opportunities, improvements in digital infrastructure, and China+ tailwinds, which endear investors to diversify their investments to mitigate geopolitical and supply chain risks. But what sector opportunities are investors considering in India? The capital inflow has largely been to traditional sectors like BFSI (Banking, Financial Services, and Insurance), healthcare, and energy, alongside consumer tech sectors whereas the notable exits have only been from the healthcare and fintech sectors, with companies such as KKR exiting Max Healthcare with a value of $1.6 billion. 

Source Countries and Sectors

Key source countries for PE/VC investments in India have been the US, UK, Singapore, Japan, China, UAE, Germany, and Canada. US investments in India went into sectors like e-commerce, fintech, and healthcare. UK investments went largely to infrastructure and education. Japan's investments went into the automotive and infrastructure sectors. The UAE focused on real estate and renewable energy, whereas Germany and Canada focused on manufacturing and green energy. Despite scrutiny on Chinese investments in the region, PE/VC inflow from China largely went into e-commerce. The variation in the sectors receiving these investments might suggest that factors increasing Foreign Direct Investments may not be particularly because of the attractiveness of those industries. A discrepancy in this trend is the U.S. and European greenfield investments into India, which increased about 400% between 2021 and 2022, while investments into China declined. Many foreign investors in India cite India's demographic dividend, democratic framework, growth opportunities, and the US's ongoing trade wars with China (and how that may shift regional power) as the reasons behind these investments. In light of this, one wonders how the Indian government responds to these investments.

Regulatory Environment and Policy Reforms

In the past decade, the Indian government has enacted several policies that appear to reform key areas of the Indian economy while incentivizing foreign investors. Initiatives such the Skill India Mission, launched in 2015, aimed to train over 400 million people in India through sub-missions such as the Pradhan Mantri Kaushal Vikas Yojana (PMKVY). In 2019, the government also increased the minimum wage for all workers and passed the 'Code on Wages' to ensure timely payment to employees across industries. These policies have led to a surge in the employability of many Indians in key areas such as software engineering, with many firms, especially in Silicon Valley, turning to Indian talent for labor. Impressively, the Maternity Benefit (Amendment) Act was passed in 2017 to extend maternity leave from 12 weeks to 26 weeks, encouraging women to remain in the workforce post-childbirth. Each of these policies, aimed at increasing the labor population in the economy, has played a crucial role in endearing foreign investors to describe the Indian labor population as 'an alternative to the Chinese labor force'. Similarly, these policies have attracted labor from different regions of Indian's economy to participate in the economy, signaling a shift towards creating more inclusive institutions.

"Stable democracies offer a system where collective choices can be made without sacrificing individual freedoms" (Olson, 1993), a theme that is evident in the policies pursued by the government in recent years. The Goods and Services Tax (GST), implemented in 2017, replaced a slew of indirect taxes with a single tax which significantly reduced the cost of doing business, especially for foreign corporations and investors, in India. Policies such as the Insolvency and Bankruptcy Code (IBC) amended laws regarding insolvency resolutions and increased entrepreneurs' risk appetite, an essential factor in innovation capabilities of any economy. And in 2016, the National Intellectual Property Rights (IPR) Policy was enacted to promote IP (intellectual Property) across the country, fostering innovation and creativity and protecting the creative work of entrepreneurs and investors. These policies specifically unlocked the flow of FDI into India and made Indian markets more acceptable to 'risk-loving' cultures such as the United States as investors increasingly believed their capital was protected, and entrepreneurs felt more comfortable knowing their ideas were protected.

In light of these policy amendments, there have been observable wins in India's capabilities to innovate and decentralize innovation. The launch of Chandrayaan-2, India's second lunar exploration mission involving a lunar orbiter, demonstrated the capability of local minds and entrepreneurs to innovate. Similarly, there has been a highly efficient demonstration of technology adoption among Indian citizens through strong government implementation programs, as seen in India's development of CoWIN to manage India's COVID-19 Vaccination drive. This innovation, which saw both public and private collaboration, demonstrated India's ability to enforce digital innovations. This was also evident in the implementation of the Unified Payments Interface (UPI), which consolidated multiple bank accounts into a single mobile application and made it simple to move capital within India's economy. The success of this program, led by government and private efforts, demonstrated India's ability not only to innovate but also to diffuse and implement solutions effectively.

Innovation and Workforce Skills

FDI plays a crucial role in bridging the technology gap and fostering innovation within the Indian economy, facilitating the country's path towards becoming an industrial economy. However, the analysis of foreign investors on the skill of India's workforce and the state of innovation reveals areas requiring significant attention. A survey by IBM found that approximately 70% of venture capitalists pinpointed the lack of a skilled workforce as a crucial challenge, aligning with findings that 80% of engineering graduates are deemed unemployable. This discrepancy highlights a strong skills gap in the economy, raising several questions about whether the quality of education in the country aligns with global standards. Moreover, more than 90% of startups in India fail in their first five years, a failure rate within the range seen across the globe. However, in India's case, 77% of PE-VC investors surveyed attributed this failure predominantly to a lack of pioneering innovation. This suggests that Indian entrepreneurs are largely adopting foreign technologies for India's growing middle-class market without necessarily innovating 'zero-to-one' technologies. In 'The Competitive Advantage of Nations', Michael Porter, Harvard Business School Professor, argued that prosperity in a country is not inherited but created, and that innovation is a key driver in developing competitive advantage and leading the world in innovation. By this standard, India, for now, does not have a competitive advantage in innovation. 

Socio-economic Impacts

FDI in India, despite its impressive feats, is not evenly spread across the country. The vast majority of the 60,000 startups in India are concentrated in the capital and have been led by students from prestigious institutions like the Indian Institutes of Technology (IITs) and Indian Institutes of Management (IIMs). This indicates a skewed distribution of wealth across the country. Also, investment in infrastructure construction, for example, has seen massive growth, with a CAGR (Compound Annual Growth Rate) of 37.4%, which signifies a push towards urban development. This is accompanied by non-manufacturing sectors such as banking and insurance, attracting more than 46% of the country's total cumulative FDI equity since March 2020. This sectoral focus may have contributed to the growth of urban areas. This could potentially lead to challenges associated with urbanization, such as congestion and pollution. This urban-centric and specific sector development also has implications for income inequality and exacerbates urban-rural divides. A study that examines the effect of FDI on gender inequality in India found that while it increases employment of unskilled female workers, it also worsens the gender-wide gap. In analyzing India's policy implementations, one realizes that without government interventions, many of these innovations do not reach the rural parts of India. These disturbing characteristics raise the question of whether increasing FDI in India is creating more extractive institutions and marginalizing more people from participating in the economy. "Inclusive institutions foster economic activity, productivity growth, and economic prosperity" (Acemoglu & Robinson, 2012). There are disturbing signs in the creation of fewer inclusive institutions amidst rising FDI (PE-VC) and this may limit India's path towards sustainable industrial development. To understand the reasons behind India's sustained PE-VC investment amidst global declines, it's essential to examine the diversity of these investments and their direct correlation with economic growth, innovation, and job creation. Despite the surge in India's capabilities to innovate, India's 18th rank in global PE-VC attractiveness demonstrate negative signs in its governance and markets: regulatory environments, market size, startup ecosystem maturity, and geopolitical influences.

The recent insights into India's enduring appeal to private equity and venture capital investments, examined through the prisms of investment diversity, the regulatory landscape, and geopolitical factors, reveal a complex picture. Although India has made significant strides in policy reforms aimed at promoting innovation and economic growth, challenges such as the expanding skills gap associated with foreign direct PE-VC investments, the struggle to nurture homegrown innovation, and the pursuit of equitable development underscore a critical reality: India, in the short term, remains on a complex unsettled journey towards becoming an advanced industrial economy; in the long term, India shows promising capabilities of becoming an advanced industrial economy, contingent on its ability to address the negative signs associated with its recent sector growths. 


-Written in February, 2024.


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