Why is foreign direct investment into India declining ?

Foreign direct investment in India fell by nearly a quarter in the first seven months of 2010 and the much-publicised chaos around preparations for the Commonwealth Games has added to worries foreign firms could put off further investment.

A UN survey found investors ranked India as the second top-priority destination for FDI this year, replacing the United States , after China. Following are some questions and answers on foreign investment flows into India.

Why are FDI flows important for India?

India needs inflows to drive investment in infrastructure, a lack of which is often cited as restricting the country's economic growth. Investment is also needed to expand capacity and technology in sectors such as autos and steel, as well as to offset a big current account deficit.

In 2009, India attracted $36.6 billion in FDI funds, equivalent to 2.7 percent of its gross domestic product. China attracted $95 billion, or 1.9 percent of GDP. But foreign direct investment flows into India fell by over 24 percent in the first seven months this year to $12.56 billion, putting pressure on domestic investment to take up the slack.

Why have FDI flows slowed down?

The slow pace of policy reform that would further open sectors such as retail, insurance and real estate to foreign investment have acted as a deterrent.

Delays in framing a new land acquisition act, which would ease availability of land for industry, have also hurt FDI flows into infrastructure and other sectors. FDI flows to India are likely to remain subdued in coming months as well, analysts said, given the shaky global recovery.

That's a contrast to flows of foreign funds into Indian stocks, which are on track to hit a record high this year. FDI flows into India, which held up reasonably well during the global financial crisis, are likely to total between $20 billion and $30 billion in 2010, economists say.

Will the Commonwealth Games have an impact on FDI?

Negative publicity surrounding preparations for the Commonwealth Games, which opened in New Delhi on Sunday, could hurt sentiment among portfolio investors, but is unlikely to have a big impact on FDI flows.

A report by credit research agency Moody's Analytics said negative publicity around the Commonwealth Games could tarnish India's image as a foreign investment destination as it reflected poorly on India's capacity to handle big projects. The games chaos may give multinationals considering expanding in India reason to think twice, Moody's Analytics said.

However, most major corporate investors are aware of the challenges of doing business in India and will focus on the longer-term opportunities in a country where the 1.2 billion population is growing at a rapid 8.5 percent a year.

Which sectors are facing slowdown?

FDI flows in financial services, real estate and power fell as regulatory restrictions and strong domestic investment squeezed out some foreign bidders for high-return projects.

FDI flows to real estate declined to 6 percent of total FDI flows during the June quarter from 11 percent in 2009/10, while flows to the services sector fell to 11 percent from 17 percent. However, FDI in telecoms, at about $1 billion during the June quarter, formed 16 percent of the total FDI funds during the period, up from 10 percent in the 2009/10 fiscal year.

Big foreign firms have had mixed success investing in India. Vodafone paid $11 billion for control of an Indian mobile carrier but earlier this year booked a 2.3 billion pound ($3.64 billion) charge on its business due to fierce competition and the high cost of wireless spectrum.

South Korea's Posco has endured more than three years of delay for a $12 billion steel plant in Orissa state due to protests by farmers. London-based Vedanta Resources said in August it had reached a deal to pay up to $9.6 billion for control of oil producer Cairn India .

How will a decline in FDI affect the current account deficit?

The trade ministry forecasts that the current account gap will reach 3 percent of GDP this fiscal year, or about $46.4 billion. Officials have said that India may end up with a balance of payments deficit this year given the rapid expansion in the current account deficit and fall in FDI. If so, massive foreign exchange reserves of some $291 billion will be more than sufficient to fund the gap.

What is the impact of FDI flows on monetary policy?

A fall in FDI inflows will keep the balance of payments under pressure and could undermine the rupee. If commodity and oil prices rise globally, a weaker rupee will add to inflationary pressures.

With fighting inflation is the central bank's top priority, any development that could push up prices will be carefully watched and play into its thinking on tightening monetary policy.

On the other hand, a wider deficit could lead to some liquidity tightness in the market, helping the central bank's five rate hikes so far this year be passed on more effectively.

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