Why has net FDI inflow plummeted? Data

The Hindu

11-06-2025

The RBI Bulletin (May 2025) provides foreign direct investment (FDI) figures for the fiscal year 2024-25. Two contrasting narratives have emerged from it. Focusing on the headline number, government sources and many media outlets have reported that India received an unprecedented $81 billion of gross inflows.
Looking closer at the same data, others have highlighted the plummeting of net FDI at $353 million. The government and economists monitor these flows as a barometer of the investment climate.
In principle, FDI inflows enhance fixed investments to expand production capacity and bring in newer technologies and global best practices. The reality, however, could be different. So, what do the contrasting numbers reveal?
To interpret the economic significance of the figures, it is necessary to relate them to the country's GDP. The gross foreign inflow-to-GDP ratio steadily declined from 3.1% in 2020-21 to 2.1% in 2024-25.
However, the decline was slightly steeper in net FDI, from 1.6% of GDP to zero in the same period, highlighting the divergence between the two flows. The graph also shows a steadily rising outward FDI (OFDI) and 'repatriation and disinvestment' (disinvestment, for short) to account for the difference between the two figures (Chart 1).
Outward FDI refers to Indian companies investing abroad to expand their market and acquire technologies to enhance their domestic capabilities. However, OFDI also includes financial flows to many known tax havens, such as Singapore and Mauritius, which are also the top sources of India's inward FDI.
Many have questioned whether such a symmetric inflow and outflow of foreign capital to tax havens represents correlated movements of 'hot money' entering and exiting the country at will. Such flows may hardly expand domestic investment but may allow for global capital tax arbitrage.
In a research paper titled 'What Does Measured FDI Actually Measure?' (October 2016), Olivier Blanchard and Julien Acalin showed that inward and outward FDI flows across emerging market economies are highly correlated, responding to the U.S. policy rate. Large financial conglomerates move liquid capital across the world to take advantage of variations in tax laws, a practice known as 'treaty shopping'.
The study found that India ranked sixth in descending order among 25 emerging market economies in terms of this correlation while China ranked 25th. The study's sharp conclusions seem instructive: '...'measured' FDI gross flows are quite different from true flows and may reflect flows through, rather than to, the country, with stops due in part to (legal) tax optimisation.
This must be a warning to both researchers and policymakers.' In other words, such flows represent the movement of global capital through India to take advantage of tax concessions, and there is a need to assess the value of these flows.
The rising disinvestment is due to the type of FDI India is attracting. The share of private equity (PE) and venture capital (VC) in FDI inflows, commonly referred to as 'alternative investment funds', has increased steadily. By definition, these funds acquire existing firms, factories, and brands, known as brownfield FDI. PE/VC investments have a 3-5-year horizon, and they are made primarily in services such as fintech, retail, healthcare, real estate, banking, and insurance.
For instance, Blackstone is investing in Care Hospitals, and ChrysCapital is investing in Lenskart . Such funds are loosely regulated entities that, almost by definition, sell (or liquidate) their holdings ('positions') during the stock market booms – to deliver the best returns for their global investors. It is quite plausible that PE/VC funds selling their holdings during the stock boom boosted disinvestment in FY25.
An estimate of the share of PE/VC funds in FDI inflow shows a steady rise during the last decade, from 12.2% in 2009-10 to over 75.9% in 2020-21 (Chart 2) ('Reversing India's Industrial Decline,' EPW, March 15, 2025). In contrast, a declining share of FDI is invested in greenfield projects, contributing modestly to capital formation.
Despite much hand-wringing, it is essential to appreciate that FDI inflows are a modest and declining share of gross fixed capital formation (GFCF). The gross inflows peaked at 7.5% of GFCF in FY21 in the past decade at current prices, declining precipitously thereafter (Chart 3). The same applies to the net FDI-to-GDP ratio.
Net FDI (and gross FDI), relative to GDP, has declined steadily since FY21. This, in contrast to many policymakers' optimistic claims, is a matter of concern. Declining interest in India among foreign investors is in line with tepid domestic corporate investment. However, it is worth noting that FDI inflow has been modest, ranging between 1% and 3% of GDP and 1% and 7% of GFCF since FY14.
There are, however, more serious concerns about the composition and utilisation of FDI. The majority of it consists of alternative investment funds, which hardly contribute to enhancing long-term capital formation, technology acquisition, and augmenting India's potential output.
The rising share of outward FDI suggests that India may be used as a conduit for tax arbitrage by international capital. If these concerns are valid, there may be a need to reform foreign capital regulations to serve domestic interests and improve domestic capabilities to overcome industrial and technological challenges.
R. Nagaraj is with the Centre for Liberal Education, IIT Bombay