UPSC DAW Mains Answer Writing 2025 8th September

UPSC DAW Mains Answer Writing 2025 8th September

Question

Despite high GDP growth, India has seen low foreign capital inflows in recent years. Examine the causes, implications for the economy and measures to attract sustainable foreign investment. (15 marks, 250 words)

Model Answer

India has emerged as the world’s fastest-growing major economy, with an average annual GDP growth of 8.2% between 2021 and 2024, surpassing countries like Vietnam, China, Malaysia, and the US. In 2025, India maintained strong growth with 7.8% year-on-year GDP growth. Despite this robust performance, foreign capital inflows, including Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI), have been subdued. 

Causes of Low Foreign Capital Inflows  

  • Structural Bottlenecks in India 

  • Infrastructure gaps: Despite improvements, inadequate transport, energy, and logistics infrastructure increase investment costs. 

  • Regulatory hurdles: Complex land acquisition laws, environmental clearances, and bureaucratic delays deter large-scale FDI projects. 

  • Frequent policy shifts in sectors like e-commerce, data localization, and taxation create apprehension among foreign investors. 

  • Volatility in Domestic Financial Markets 

  • Indian equities and bond markets have faced inflationary pressures and currency depreciation, discouraging FPI inflows. 

  • Domestic Indian firms investing abroad reduce net capital available domestically (rose from $13 billion in FY 2011–12 to $30 billion in FY 2024–25). This was driven by domestic regulatory inefficiencies, infrastructure gaps, and policy unpredictability. 

  • The Indian rupee has hit lows (88/$), partly due to capital outflows and global uncertainties, discouraging foreign investors. 

  • Competition from Other Emerging Economies 

  • Countries like Vietnam, Indonesia, and Bangladesh offer lower costs and export incentives, diverting foreign investment away from India. 

  • Trade Deficits and External Vulnerabilities: 

  • India’s merchandise trade deficit has risen to $285 billion in 2024-25 due to imports exceeding exports. This widening of deficits or reduced capital inflows could threaten external stability.  

  • Investor Concerns: 

  • Rising interest rates in the U.S. and Europe, coupled with geopolitical tensions have led to capital outflows from emerging markets.  

  • Investors prefer safe-haven assets rather than emerging market equities or bonds like India. 

  • Global trade tensions, e.g., potential US tariffs on Indian goods worth $86.5 billion, create uncertainty. 

Implications for the Indian Economy 

  • Financing Growth: 

  • India, being a capital-scarce economy, relies on foreign capital to supplement domestic savings.  

  • Lower inflows limit investment in infrastructure, manufacturing, and technology. 

  • Impact on Stock Markets: 

  • Equity market volatility increases due to FPIs pulling out, affecting domestic investor confidence and capital raising by companies. 

  • Balance of Payments: 

  • Lower foreign inflows strain BOP and may impact foreign exchange reserves in scenarios of rising trade deficits or global shocks. 

  • Sustainability of Growth: 

  • Without stable foreign capital, India may face challenges in maintaining high investment rates necessary to sustain GDP growth above 7% in the medium term. 

  • Limited Industrial Growth 

  • Decline in manufacturing investment weakens long-term growth and innovation. 

  • Employment Challenges 

  •  Reduced FDI in labour-intensive sectors limits job creation. 

Measures to Attract Sustainable Foreign Investment 

  • Strengthen Ease of Doing Business: 

  • Continued reforms, such as the GST rate cuts and next-generation regulatory task forces, improve the business climate for foreign investors. 

  • Promote FDI in Productive Sectors: 

  • Encourage investments in manufacturing, green energy, technology, and infrastructure with clear exit norms to ensure confidence. 

  • Stable Macroeconomic Policies: 

  • Fiscal prudence, inflation control, and stable monetary policy will reassure investors regarding returns and currency risk. 

  • Develop Domestic Capital Markets: 

  • Strengthen domestic institutional investors to absorb FPI exits, maintain liquidity, and provide stable valuations for IPOs and secondary markets. 

  • Risk Mitigation for Global Shocks: 

  • Bilateral and multilateral agreements, hedging mechanisms, and trade diversification reduce vulnerability to global trade shocks. 

  • Leverage External Commercial Borrowings (ECB): 

  • ECBs, which rose to $16 billion in 2024-25, can supplement FDI and FPIs, especially for infrastructure projects with long gestation periods.  India’s high GDP growth presents a compelling case for foreign capital inflows. However, cautious investor sentiment, past investment exits, trade deficits, and global uncertainties have constrained flows. Strategic reforms, corporate governance improvements, and market development are essential to attract sustainable foreign investment, ensuring that India’s growth story is both resilient and inclusive.