In 2023, India saw a significant 43% drop in FDI inflows, but the heightened focus on manufacturing and infra development calls for FDI-friendly measures
Analysts have called for a sharper focus on policies and measures that will drive foreign direct investment in line with global investing themes such as ‘China+1’, cleantech and green energy, AI development
Besides this, FM Sitharaman, in the budget, may relax FDI regulations for growth sectors such as defence, and agriculture, thereby attracting more investments and fuelling job-creation
In the build-up to the Union Budget 2024-25, we have noted a lot of optimism among startup ecosystem stakeholders. For one, there’s a feeling that this budget will see heightened government spending for key areas such as foreign direct investments or FDI to drive economic growth.
We have already reported about how those catering to the consumer class have called for a focus on job creation through higher allocation for infrastructure creation and the manufacturing industry. These two areas are seen as pivotal for the Indian economic growth story, particularly as the focus has been on improving per capita income metrics by expanding the so-called middle class.
While on paper, focussing on infrastructure and manufacturing may seem obvious, it is not necessary for the Indian government to cater to this through government revenue and collections alone. The record $25 Bn (INR 2.1 Lakh Cr) surplus transfer from the Reserve Bank of India to the central government is certainly a great way to fund infrastructure spending. This gives finance minister Nirmala Sitharaman and her ministry more room to spend without expanding the national fiscal deficit.
Recent statistics from the RBI also highlight the pressing need to alleviate issues in the way of FDI in India. The country saw a significant 62% drop in FDI inflows in FY24, with the total FDI figure falling to $10.58 Bn.
India’s position fell from 8th in 2022 to 15th in 2023 in global FDI inflow rankings. Even though FDI inflow declined in 2022 as well by 10% compared to 2021, the total investment was still close to $49 Bn. In light of this, analysts have called for a sharper focus on policies and measures that will drive foreign direct investment in line with global investing themes such as ‘China+1’, cleantech and green energy, AI development as well as digital banking and financial inclusion.
Besides this, it is expected that the upcoming budget may relax FDI regulations for growth sectors such as defence, and agriculture, thereby attracting more investments and fuelling job creation.
Will Budget 2024 Fix FDI Blues?
In February’s interim budget, the finance ministry increased allocation by 33% for the PLI schemes related to manufacturing. But as per those in the manufacturing industry, sharper focus is needed across 14 key sectors that are linked to manufacturing.
So far, the government’s push has primarily been on electronics manufacturing, which has seen consumer tech giants such as Apple, Samsung and Google increase their manufacturing footprint in India through local partners.
As per the India Cellular and Electronics Association (ICEA) data, India’s electronics manufacturing output reached a record-breaking $115 Bn market in FY24, with $29.1 Bn in electronics exports, making electronics the fifth-largest export category from India.
With PLI schemes restricted to certain sectors of manufacturing, foreign investments — whether it is in capacity building or capex — are restricted to those sectors alone.
Besides smartphones and mobile devices, analysts have called for a big push on pharmaceuticals, automobiles, semiconductors, toys, textiles, apparel, and commercial aircraft. According to Kaushik Mudda, cofounder and CEO of deeptech startup Ethereal Machines, the PLI schemes need to be tailored such that the benefits can trickle down the manufacturing value chain, with component makers and those creating manufacturing tech also garnering foreign investments.
“While the budget announcements are awaited, I think the government’s preliminary steps are on the right track as it has covered the first layer to start with. But if it wants to achieve the scale it is looking at in a very short span of time, the government should start thinking a bit broader,” the CEO of Ethereal Machines added.
Fuelling China+One Movement
A day ahead of the Union Budget, the Economic Survey suggested that increased FDI inflows from investors looking to diversify away from China can be a big boost for India.
“China is India’s top import partner, and the trade deficit with China has been growing. As the US and Europe shift their immediate sourcing away from China, it is more effective to have Chinese companies invest in India and then export the products to these markets rather than importing from China, adding minimal value, and then re-exporting them,” the survey stated.
Will FDI Chase Green Manufacturing?
Besides these expectations, those working in the green energy and cleantech space pointed at the disparity in the PLI schemes in the energy manufacturing sector.
For instance, a majority portion of the INR 19,744 Cr PLI budget for green hydrogen goes for the production of green hydrogen molecules and manufacturing of electrolysers at scale, and those who miss out are companies working in capacity building such as manufacturing efficiency, supply chain platforms and intellectual property-related models.
The current structure of PLIs in green energy manufacturing is in favour of importing existing technologies, rather than building up India’s capabilities in areas that are imports-reliant.
In this regard, one key expectation of those in the climate tech sector is introduction of green FDI through international carbon market mechanisms. This would not only attract capital for decarbonisation efforts but also put India among the leading nations for climate-related innovation.
The climate tech industry feels that the budget allocations over the years have failed to support the scaling up of renewable energy infrastructure. Reducing customs duties on imports for the solar energy industry, expanding green and climate finance through registered entities, and revising GST on renewable energy production and sources could be some signals to international investors to back Indian businesses.
A January 2024 report by the World Economic Forum and Bain & Company ranked India as the world’s third-largest economy in terms of energy requirements, with energy demand projected to increase by 35% by 2030. In 2022, India’s energy import bill totalled $185 Bn, which underscores the need to build green capacity to support domestic energy demand.
A Game Of Taxes, Subsidies And Exemptions
Ease of doing business has always been a hot topic in India. The policy measures over the past 10 years have certainly improved India’s position in this regard, but taxation remains the single biggest sore point for foreign investors in India.
As ever, the industry is eyeing proposals from the finance minister that will reduce the tax burden on companies and individuals, as well as more simplified compliance procedures to resolve tax-related issues.
These are considered to be vital to fuel private equity inflow into Indian startups as well as companies in hot sectors. The wide expectation is a reduction in corporate tax rates to align with global standards, making India a more attractive destination for foreign investors. An economist at Kotak Mahindra Bank said that while industry-wide tax cuts are unlikely, key sectors that desperately need FDI for growth and capacity building need to be given a longer rope.
For instance, the manufacturing industry believes that an extension of the sunset date for the 15% tax regime for new manufacturing entities by another fiscal year will prove to be a major factor pulling in FDI.
The current scheme allows for a 15% tax rate for manufacturing companies set up on or before March 31, 2024. Many believe that in addition to production-linked incentives in manufacturing (PLI), the favourable tax positions for new manufacturing companies will drive FDI in this space, which is interlinked with several other sectors.
Despite the relatively cushy position of the central government given high tax collections and the RBI dividend, economists and analysts caution against overenthusiasm on issues such as changes in the long-term capital gains exemption thresholds, or significant tax breaks for sectors such as healthcare, education and others.
On the other hand, tax rebates could be seen in investments in climate tech and green energy, but as expected there is no certainty on how this might be implemented by the government. “If tax incentives in climate tech necessitate fresh investments, this could make large-scale investments in conglomerates attractive, but it won’t exactly be a boon for MSMEs or startups. We’ll have to wait and see how the government looks to enable smaller businesses in this space as the focus is always on large-scale energy production,” said the Kotak economist quoted above.
As reported by Inc42 last week, Indian startup investors are looking forward to clarity on tax liabilities, prevent double taxation, and offer favourable tax treatment to entities redomiciling to India. The experiences of PhonePe, Groww and other startups has shown that reverse flipping isn’t without its pitfalls.
Archit Gupta, cofounder and CEO of fintech unicorn Clear, told Inc42 that advance rulings or certifications from tax authorities regarding the tax implications of redomiciling will provide certainty to startups and foreign investors.
The industry experts said that tax exemptions or reductions for strategic relocations, especially for startups in priority sectors could be a massive boost for FDI. The “Onshoring Indian Innovation to GIFT IFSC” report suggested a comprehensive scheme to help startups relocate to India in a tax-free manner, implementing parts of which could be the way forward.
Indian founders are hopeful that the upcoming budget will endorse the report, allowing flipped startups to redomicile with the lowest possible tax burden, reducing the tax burden for investors in India in the short and long run.
