3- India’s External Sector: Getting Foreign Direct Investment (FDI) Right

Introduction

The external sector plays a crucial role in a country’s economic growth and stability, encompassing trade, foreign investment, external debt, foreign exchange reserves, and global market integration. India’s external sector has shown resilience amid global headwinds such as trade protectionism, geopolitical risks, supply chain disruptions, and climate-related uncertainties.

The Indian economy, supported by strong fundamentals and policy measures, has witnessed steady export growth and rising foreign direct investment (FDI). However, challenges such as trade imbalances, capital outflows, and evolving global trade dynamics require continuous policy recalibration.

This chapter provides an in-depth analysis of India’s external sector, covering global trade trends, India’s trade performance, services exports, balance of payments, foreign exchange reserves, and external debt. It also examines the impact of global uncertainties, protectionist measures, and technological advancements on India’s trade and investment policies.

Global Trade Dynamics

  • Geopolitical tensions and economic uncertainties have created volatility in global trade.
  • The Global Economic Policy Uncertainty (GEPU) Index remains high due to factors like trade tensions, monetary policy shifts, and climate-related disruptions.
  • The Trade Policy Uncertainty (TPU) Index has increased since late 2023, reflecting tariff changes and protectionist measures by major economies.
  • The Geopolitical Risk (GPR) Index has surged due to conflicts in key trade routes like the Red Sea and the Strait of Hormuz.

Global Trade Performance in 2024

  • Total global trade is projected to reach USD 33 trillion in 2024, with services trade growing by 7% year-on-year.
  • Merchandise trade, however, remains below the 2022 peak, growing at 2% annually due to supply chain disruptions and inflationary pressures.
  • Developed economies witnessed a trade resurgence, while East Asian trade stagnated due to reduced demand for consumer electronics and industrial goods.

Protectionism and Non-Tariff Measures (NTMs)

  • Tariffs have declined globally, but non-tariff measures (NTMs) have increased significantly.
  • Technical barriers to trade (TBTs) impact 31.6% of global products, covering 67.1% of world trade.
  • Climate-related NTMs, such as the Carbon Border Adjustment Mechanism (CBAM), are reshaping global trade by imposing stringent environmental compliance measures.

India’s Trade Performance in FY25

  • Total exports (merchandise + services) reached USD 602.6 billion in April-December 2024, growing at 6% year-on-year.
  • Total imports increased by 6.9%, reaching USD 682.2 billion, reflecting strong domestic demand.
  • The overall trade deficit widened to USD 79.5 billion compared to USD 69.7 billion in the previous year.

Sectoral Performance of Merchandise Exports

  • Engineering goods exports grew by 9.9%, driven by demand for automobile components and industrial machinery.
  • Pharmaceutical exports rose by 6.4%, with increased shipments to Europe and Africa.
  • Electronics exports surged by 28.6%, benefiting from the Production-Linked Incentive (PLI) scheme.
  • Textile exports rebounded by 7.6%, driven by man-made fiber (MMF) products.

Imports and Trade Deficit

  • Non-oil, non-gold imports increased by 7.1%, reflecting a rise in capital goods and machinery imports.
  • Gold imports rose due to higher global prices, impacting the current account balance.
  • The merchandise trade deficit widened to USD 210.8 billion, necessitating measures to boost export competitiveness.

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India’s Services Trade and E-Commerce Exports

Growth in Services Exports

  • India’s services exports grew by 11.6%, contributing USD 131.3 billion in net receipts.
  • IT and business services remain the key drivers, with India capturing 10.2% of global IT service exports.
  • Travel and transport services witnessed a slower recovery, reflecting global economic uncertainty.

E-Commerce Exports

  • India’s B2C (Business-to-Consumer) e-commerce market is projected to grow to USD 150 billion by 2026.
  • Cross-border e-commerce exports could reach USD 200-300 billion by 2030, driven by MSME (Micro, Small & Medium Enterprises) participation.
  • Government initiatives like the E-Commerce Export Hub (ECEH) and Niryat Bandhu Scheme are facilitating online exports.

Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI)

  • Gross FDI inflows showed a revival in FY25, but net FDI declined due to increased repatriation.
  • Top FDI sectors: IT, renewable energy, financial services, and pharmaceuticals.
  • Leading sources of FDI: Singapore, USA, UAE, and the Netherlands.

Foreign Portfolio Investments (FPI)

  • FPI inflows remained volatile, impacted by global interest rate trends and geopolitical risks.
  • Domestic equity markets saw net positive inflows, reflecting investor confidence in India’s growth story.

India’s Balance of Payments (BoP) and Foreign Exchange Reserves

  • The current account deficit (CAD) widened due to trade imbalances, but remained manageable at 1.6% of GDP.
  • The capital account showed resilience, supported by stable FDI inflows and remittances.
  • Net remittances reached USD 112 billion, a key support for external balances.

Foreign Exchange Reserves and Exchange Rate Movements

  • India’s foreign exchange reserves stood at USD 640.3 billion in December 2024, covering 90% of external debt.
  • The Indian rupee remained stable, supported by RBI interventions and strong macroeconomic fundamentals.

India’s External Debt and Risk Management

India’s External Debt Position

  • Total external debt stood at USD 711.8 billion as of September 2024.
  • Short-term debt accounted for 18.6% of total external liabilities, ensuring manageable rollover risks.
  • Debt service ratio remained stable at 5.4%, indicating India’s strong repayment capacity.

Risk Management Strategies

  • Prudent external borrowing policies have helped India maintain a comfortable debt profile.
  • The RBI’s forex reserves provide a strong buffer, reducing the risks of external shocks.

Conclusion

India’s external sector has demonstrated resilience and adaptability amid global uncertainties. Robust exports, stable FDI inflows, and strong foreign exchange reserves have provided a cushion against external shocks. However, challenges such as rising trade imbalances, protectionist policies, and volatile capital flows require continued policy vigilance.

Going forward, India must diversify its export basket, enhance trade competitiveness, and strengthen regional trade partnerships to sustain its global trade momentum. Policy measures should focus on reducing logistics costs, improving ease of doing business, and leveraging digital trade opportunities to boost India’s external sector performance in the coming years.

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