DEBATES and discussions on foreign direct investment (FDI) abound in India. While most of these debates concentrate on the policies of the Indian government regarding FDI, some also examine the quantum of FDI received by India and its impact on the nation’s economy. In all such situations, comparisons of India with China are inevitable. This paper too is a Sino-India FDI comparison along with an analysis on how each country is exploiting international markets. The focus and approach, however, is growth and development centric.

It is to state the obvious that China is receiving more FDI than India; it is also a truism that FDI has been a key player in China’s growth. However, the same cannot be said about India. The issue, therefore, is to analyse the economic impact of FDI into China and state clearly the lessons that India can learn from this. In India, while most are in agreement about the need to augment more FDI, there is still lack of clarity on the exact modes through which FDI should be encouraged so as to ensure a positive outcome for the economy. It seems looking East would be helpful. To take an important example, FDI into China is more export-oriented and generates more employment than has been the case for India.¹ Therefore, not only is it important to focus on the quantum of FDI into India but also the direction it takes.

FDI into China has also helped it exploit international markets as China has now become an international manufacturing hub. Currently, China alone accounts for 8.4% of the world’s total manufacturing.² The most important reason for this is that FDI in China is concentrated on export-oriented manufacturing. As of 2002, Foreign Invested Enterprises (FIEs), accounted for over 52% of China’s total exports. Only twelve years ago in 1990, this figure was 12.6%. Such export orientation of FDI has meant that most of the monies invested in China are geared towards exploiting international markets. By contrast, FDI in India does not have a similar export orientation and caters primarily to the local market.

Briefly looking into the socioeconomic indicators of the two countries, it is clear that China outperforms India in almost all respects (see Table 1 below). It has higher growth rates and higher per capita income. It has a positive trade balance of $79 billion, while India has a large trade deficit of $32 billion. China also has over six times more foreign exchange reserves than India. Manufacturing value added as a percentage of GDP is 39% in China, while it is only 16% in India. Value added in the service sector as a percentage of GDP is however higher in India than China. Not that this is necessarily good because it is indicative of the fact that India has become a service dominated economy without ever having industrialised.

 

The situation repeats itself while analysing FDI. Between 1991 and 2004, India received a cumulative FDI of over $38 billion. China, over the same period accumulated over $510 billion in FDI.³ While it is true that a better performing economy will attract more FDI, it is also the case that larger inflows of FDI have a positive effect on the economy. Therefore, the link between FDI and economic development is a two-way one – higher FDI augments economic growth and higher growth attracts more FDI. However, the real picture is not as black and white. India and China’s FDI statistics in the strictest sense cannot be compared. Therefore, a review of the caveats involved in a Sino-India FDI comparison is important. It is, however, useful to note that even after adjusting for these factors, China fares much better than India in terms of attracting FDI.⁴

 

China’s FDI figures are more inclusive in nature than Indian FDI statistics provided by the Reserve Bank of India. The first source of discrepancy is how both countries define FDI. India’s FDI statistics include only foreign equity capital.⁵ This is a considerably narrow definition when compared to the one used by the International Monetary Fund (IMF). Apart from just foreign equity capital, the IMF definition includes reinvested earnings of foreign companies; inter-company debt transactions; overseas borrowings of foreign direct investors etc.⁶ The reinvested earnings of MNCs mentioned here is a significant omission in India’s case. For decades, Indian foreign companies have reinvested their profits instead of repatriating them. Contrary to India, however, China ironically adheres to the IMF definition while calculating FDI. In addition, it also includes imported equipment in its FDI figures.⁷ In view of all this, it is clear that India’s FDI figures relative to China’s are underestimated.

 

Another major source of discrepancy is the process of ‘round-tripping’. This refers to capital belonging to mainland China leaving the country and then being reinvested in China in the form of FDI. Mainland Chinese investors find many incentives in doing so. First, enterprises set up through FDI enjoy many tax benefits, more administrative support and easier access to financial services.⁸ Another benefit is that property right laws are still weak in China for the local citizens. Reinvesting profits is not always easy and it is preferred to remove your profits from China and then reinvest them in the form of FDI through Foreign Invested Enterprises (FIEs), which enjoy higher protection of property rights from the government.⁹ A third incentive for ‘round-tripping’ is not as clandestine: the better financial services provided in Hong Kong also attracts mainland Chinese businesses to park their money there until they decide to reinvest it back in the local economy.¹⁰ 

 

While round-tripping severely overestimates the FDI received by China, there is no established methodology to mark out the exact extent of this overestimation. In the literature on the subject, round-tripping is estimated to range anywhere from 20% to 60% of total FDI. If we take the upper bound as our limit, then over half of Chinese FDI is spurious. Even taking a mean of these figures, around 40% of Chinese FDI can be accounted by round-tripping.

Table 2 below (from Xiao, 2004) reveals the overestimation discussed. For example, according to Chinese figures, China received $5.4 billion as FDI from the United States of America in 2002. However, American statistics show that the USA invested only $0.9 billion in China. Therefore, the difference of $4.5 billion or over 80% of China’s reportage is unaccounted for. Possibly some of this difference is due to statistical errors and definitions. However, such errors can go both ways, that is there can be an overestimation or an underestimation. While doing similar analysis between other countries, Xiao found that discrepancies tended to even themselves out. However, in China’s case, there was a constant trend of overestimation of its FDI receipts.

 

The last caveat relates to the issue of fudging. In China, for example, the Bureau responsible for attracting FDI is also the one which publishes all the FDI data. This indicates a severe conflict of interests.¹¹ While the perception may be that it is only the state that has the incentives to fudge data, studies show that private parties have enough reason to overstate their FDI receipts. In China, it is common for FIEs to state their FDI receipts well above the actual figures. As mentioned before, this is so because capital is safer in China when it has the tag of FDI. Hence, a large part of the fudging issue is related to round-tripping.

FDI in India is much lower than that of China even after adjusting the figures for discrepancies, though the actual extent of the overestimation by China and the underestimation by India in their respective FDI figures is not certain. However, without going into details of how these can be calculated, we assume that around 40% of Chinese FDI is overstated. As for India, the International Finance Corporation had argued that if India defines its FDI as per IMF guidelines, it would be around $8 billion in 2001.¹² The actual figure is around $3.6 billion and the IFC suggested figure is over 120% larger. To be more conservative, let us inflate Indian FDI figures by only 100%. Please note that these adjustments are arbitrary and simplistic and are only meant to be indicative of comparable FDI figures for India and China (see Table 3 below).

 

It is clear from the accompanying table that though the severity of the contrast between India and China reduces after adjusting the figures, the difference is still significant. Without adjusting, India is adding about $4.5 billion of FDI each year, while China is adding over $50 billion each year. Therefore, China’s FDI inflow was over 12 times more than India’s FDI inflow. Even after adjusting the data, China is still adding about four times more FDI each year compared to India. The Chinese economy is only two-and-a-half times bigger than the Indian economy and therefore getting FDI which is four times higher is a significant difference.

 

Hong Kong is the largest investor into China. In 2004, it accounted for over a third of the total FDI that came into China or about $19 billion. The United States with near 20% investment is the second largest source of FDI for China. However, this is largely due to an investment of over 12% from Virgin Islands, USA alone. Taiwan, which had a share of 5.8% in total FDI is the fifth largest contributor of FDI in China, reinforcing the point about round-tripping made earlier, in that most of Chinese FDI comes from Chinese persons investing from Hong Kong and Taiwan. Even much of FDI from other countries is a result of round tripping. An estimate by Xiao (2004) puts round-tripping from the USA, Japan and Korea at 61.8%, 51.7% and 48.8% of total FDI.¹³ 

 

Looking at these trends over time, one sees that the share of FDI from Hong Kong has reduced. In 1986, almost 60% of Chinese FDI came from Hong Kong. This reduced to around 34% by 2002. Similarly, the share of USA (excluding Virgin Islands) and Japan has also declined over the years. Both these countries accounted for about 26% of China’s FDI in 1986 and only 18% in 2002.

 

The United States is also a major investor into India. It occupies the second position, while the largest investor to India is Mauritius. However, unlike the Chinese case, this does not indicate any sort of repatriation by Non-Resident Indians (NRI investment comes under a separate head). Instead, most of this investment is actually done by American and British subsidiary companies in Mauritius that wish to avail of the Indo-Mauritius Tax Avoidance Treaty.¹⁴ Investors from Mauritius predominantly invest in the telecommunications sector (83% of total), fuel sector (51% of total) and information technology sector (31% of total). The USA is the second largest investor in information technology and accounts for 23% of the total investment in this sector. In reality, therefore, Americans are the biggest investors in our IT sector because most investors from Mauritius are Americans. Japan’s major investment is in the automobile sector and that of the Netherlands is again into IT as also the chemical sectors.¹⁵ 

 

If NRIs were a country in themselves, they would be the third largest investors in India. However, their total investment share is still only around 7% of the total. Therefore, there is considerable scope for investment by NRIs as compared to investment by Non Resident Chinese in their home country.

It is widely known that FDI in China is concentrated in the eastern coast. Not only is over 86% of total FDI in China concentrated in the eastern region, 87% of the total projects are also in the eastern region.

Correspondingly, the trade share of this region is also high. East China accounts for nearly 91% of China’s total exports. In the East, Guangdong, Shanghai and Jiangsu, have a trade share of 36.1%, 11.7% and 10.5% respectively. Over half of these exports are through FIEs, which account for 51.35% of the total trade from East China. Also, over 40% of the investment in this region is accounted for by FDI. In central China, only 9.5% of total investment is through FDI and in West China it is only 4%. One can also see a correlation between per capita income and per capita FDI. Both figures are the highest in East China and lowest in West China.

 

In India too, a concentration of FDI can be found in Gujarat (10.2%), Maharashtra (27%), Karnataka (12%) and Tamil Nadu (13%). However, this concentration is not as acute as in China. The regional spread is from the extreme West of India into the South East of the country. This region by itself accounts for over 60% of India’s total FDI and over 65% of the total approved FDI projects.

Like China, India’s FDI distribution also closely follows the trade share of these distributions. While the FDI intensive region of Gujarat, Maharashtra, Karnataka and Tamil Nadu gets over 60% of the FDI, this region also accounts for 65% of India’s total trade. The concentration of exports is especially high in Maharashtra which alone accounts for 31% of India’s exports. However, this is also a function of the fact that many companies have their registered office in Mumbai, hence increasing the reportage from there.

 

It has already been mentioned how FDI helped China become a manufacturing hub. 71% of total FDI in 2004 went to this sector, with real estate and construction placed second and accounting for 11% of total FDI. Business services is next and accounts for 4.7% of total FDI. It is also striking that agriculture and mining only got 2.7% while the services sector in total got only 8.7% of the FDI. Out of the services sector, information technology only got 1.5% of the total FDI inflow.

One important reason for a large share of FDI into China going to the manufacturing sector is its efficient and competitive labour market. The average labour cost in China was about $729 per year during 1994-99. In India, the corresponding figure was much higher at $1192¹⁶ indicating an advantage for China in terms of lower labour costs. This advantage has helped China become a manufacturing hub. Many investors from Hong Kong and Taiwan found it profitable to set up manufacturing factories in China that were largely based on export production. However, recent news reports suggest that this advantage is eroding. There is now a marginal excess of demand for labour than supply, thereby increasing wages.¹⁷ 

 

It is interesting to compare the sectoral distribution of FDI into China with that of India. While the manufacturing sector is also a major recipient of FDI in India, its share is only 26.5%, much lower than China’s 71%. India’s IT sector, however, receives a considerable share of FDI. IT in India receives 20.2% of total FDI; the corresponding figure in China is only 1.5%. The total share of FDI to the services sector (including IT and telecommunications) is therefore over 40%. In this sector, China only receives about 8.7%.

That India’s FDI goes largely into its services sector is not necessarily good. FDI in China going into the manufacturing sector has created a job market for unskilled and semi-skilled labour. The industrial sector in China employs 22% of its total labour force and accounts for over 50% of its GDP. In India, however, only 17% of the labour force is part of the industrial sector and accounts for only around 26% of GDP.¹⁸ 

 

The predominance of FDI into the services sector in India, however, does not have a similar employment effect. Employment in IT and telecommunications is largely for the skilled workforce. Probably, this workforce would have anyway found employment even if FDI wasn’t concentrated in this sector.¹⁹ However, and more important, IT and telecommunication are not even a haven for skilled workers. As of 2002, according to Nasscom figures, IT only employed 820,000 personnel or about 1.8% of the workforce. By 2008, this will only increase to two million. Therefore, IT may be a major source of export income for India but it certainly has no effect on the employment situation in the country.

China’s FDI as a percentage of its GDP peaked around 1996 to about 5%. It declined thereafter and as of 2004, the figure was 3.2%. India’s performance, however, has been much below this. India clocked FDI inflows only after the 1991 reforms. In 1992, India’s FDI as a percentage of GDP was only 0.1%. Thereafter, from 1996 to 2004, it remained at around 0.7%.

Similarly, if we analyse FDI as a percentage of total investment, we see that it peaks for China at around 1996 (14.3%) and for India at around 2000 (9.7%). Closely follows the FDI/GDP ratio analysed in Figure 1. Of course, the figure for India is lower than that of China.

Source: International Financial Statistics, International Monetary Fund.

 

After the peak of the FDI/GDP ratio in China in 1996, we see a faster rise of the share of exports as a percentage of GDP. It rose from 18.4% in 1996 to 34.5% in 2004 (see Figure 2). For India, however, the trend is not clear. While the share of exports to GDP increased after the 1991 reforms, the rate of increase is only marginal. In the pre-reform period, the export share was around 4.5%. This doubled and increased to around 9% in the post-reform period. However, the share of exports in India as of 2004 was still less than a third of China’s performance using the same indicator. This is an especially poor performance considering that in 1980 both country’s export/GDP ratio was around the same level at 5%. This indicates that while opening up the economy and the inflow of FDI has a positively impacted on India’s exports, the benefits accrued to Chinese exports through its FDI are much higher.

Source: International Financial Statistics, International Monetary Fund.

 

The Foreign Exchange to GDP ratio also portrays a similar picture. Chinese ForEx/GDP ratio increased exponentially from 15.3% to 35.5% from 1996 to 2004 (see Figure 3). India’s ForEx/GDP ratio, though lower in absolute terms, also followed a similar growth trajectory. However, this had little to do with FDI and more to do with rising NRI deposits in India and NRI income repatriation from across the world.

Source: International Financial Statistics, International Monetary Fund.

 

China, the manufacturing hub of the world, had a trade surplus of nearly $102 billion in 2005. The United States is its largest buyer accounting for over 21% of China’s exports worth $760 billion. The United States and Hong Kong are also the two major countries with which China enjoys a trade surplus – of over $110 billion each. This largely makes up for its deficit from Taiwan (-$58 billion), South Korea (-$42 billion) and Japan (-$16 billion). These figures suggest that China managed to import raw material and finished goods from a section of its trading partners in order to supply manufactured goods to the United States. It is also interesting to note that the foreign exchange reserve in China had reached about $818 billion as of 2005.²⁰ Ironically, these huge Chinese reserves in US banks are lent to American consumers, who in turn have acquired a voracious appetite for Chinese goods.

 

Contrast this to India where one can find a ‘under-exploitation’ of international markets. India, unlike China, had a trade deficit of around $29 billion in 2004-05. However, with the United States, India too has a trade surplus, though its magnitude is far lower compared to China. In 2004-05, India exported $13 billion worth of goods and services to USA while China exported $163 billion. Moreover, China’s trade surplus with the US is about $114 billion, while that of India is only $6 billion. This clearly indicates that India has not been able to exploit international markets as well as China. Moreover, the main reason for this is because of the lack of FDI into the manufacturing sector.

It is clear that there is a strong correlation between FDI and economic development in China. Regions in China receiving more FDI have higher per capita incomes. Chinese investment, exports and foreign exchange reserves closely followed FDI into the country. This is also largely because FDI in China is concentrated in the manufacturing sector.

 

The lesson for India is quite simple. India needs to augment more FDI in its manufacturing sector. This will give a boost to its exports, which in turn will make India’s GDP growth target of 10% more realistic. Higher exports will ensure a positive trade balance. Presently, India’s current account is largely stable despite a huge trade deficit only because of large scale repatriation from NRIs abroad. However, this is an unsustainable situation. It is also unadvisable to have a current account surplus that is solely dependent on remittances. One of the main reasons for the 1991 crisis was the sudden break on these remittances during the Gulf War.

Augmenting more FDI into manufacturing will also increase the employment in the sector. Presently, agriculture which accounts for only 23% of India’s GDP, shares the burden of around 60% of its workforce. Also, many of these workers are now making their way into the urban unorganised sector and finding jobs as rickshaw pullers, tea vendors, etc. This indicates a significant amount of forced employment. However, statistically these people become part of the burgeoning services sector of the economy (over 50% of GDP). Clearly, the way to create more jobs is through the manufacturing sector, and FDI into this sector will surely help.

 

Endnotes:

1. N. Kumar, ‘FDI, Exports And Jobs’, Financial Express, 16 June 2004.

2. World Development Indicators, 2005, The World Bank.

3. Source for India and China’s FDI figures: ‘International Financial Statistics’, International Monetary Fund, 2006.

4. Economic Survey of India, 2003-04, Ministry of Finance, Government of India.

5. ‘FDI to China and India: The Definitional Differences’, Nirupam Bajpai and Nandita Dasgupta, Business Line, 15 May 2004.

6. Ibid.

7. Ibid.

8. ‘People’s Republic of China’s Round-Tripping FDI: Scale, Causes and Implications’, Geng Xiao, Asian Development Bank Institute, July 2004.

9. Ibid.

10. Ibid.

11. Ibid.

12. ‘What is the True Level of FDI Flows to India?’, Sadhana Srivastava, Economic and Political Weekly, 15 February 2003.

13. ‘People’s Republic of China’s Round-Tripping FDI: Scale, Causes and Implications’, Geng Xiao, Asian Development Bank Institute, July 2004.

14. S. Majumder, ‘Budget Low on FDI Initiative’, Business Line, 10 March 2006.

15. Ibid. Actual investment is under the head of ‘electrical equipment’. This, however, is predominantly information and technology. The nomenclature decided years back still remains.

16. Statistical Outline of India, 2005-06, Department of Economics and Statistics, Tata Services Limited.

17. ‘Sharp Labour Shortage in China May Lead to World Trade Shift’, David Barboza, New York Times, 3 April 2006.

18. ‘Will India Catch-up with China?’, Mohan Guruswamy, et. al, Centre for Policy Alternatives, New Delhi, October, 2005.

19. N. Kumar, ‘FDI, Exports And Jobs’, Financial Express, 16 June 2004.

20. International Financial Statistics, International Monetary Fund