Competitive Exams: General Studies Economics FDI

Foreign Direct Investment in the Services Sector

  1. The importance of the services sector in India's economy does not need highlighting. The services sector accounts for over 55 percent of India's Gross Domestic Product. It growing by 10 percent annually, contributes about a quarter of total employment and over one-third of total exports and then is growing at a fast clip.

  2. What, however, should be emphasize is how do we sustain high growth of the services economy. This is because, the continued growth of the services sector is predicated on certain reforms. Among the various policy reforms, the single on than can contribute most to the further growth and maturing of India's services sector is making it easier for foreign direct investment in services.

  3. So far, the FDI window into services has been opened only slightly. Many areas of the services sector are altogether out of bounds for the foreign direct investor. But, despite severe restrictions, the services sector has attracted no less than 44 percent of the total FDI equity flows between April 2000 and December, 2010 in only four sectors, namely, financial and non-financial services, computer hardware and software, telecommunications and housing and real estate. If the construction sector is included, then the share of the services sector in the total equity flows will jump to 51 percent. Of these sectors, financial and non-financial companies have attracted the largest FDI equity flow with a share of 21 percent. Larger FDI flows can radically improve some of India's critical services sectors and help overcoming the challenges that are before India's services economy today. The Economic Survey of 2010 − 11 has very clearly pointed out the challenges that are facing the services economy.

Three challenges

  1. The first, and the biggest challenge, is to retain India's competitiveness in those sectors where it has already made a mark such as IT and ITeS and Telecommunications. The second challenge lies in making inroads in traditional services, such, tourism and shipping where other countries have already established themselves. The third is to make India's presence felt in globally traded services in niche areas, such as, financial services, healthcare, education, accountancy and other business services. It should be noticed that greater integration with large global players through investment and international relationship building could help in overcoming these challenges and making India a services superpower. Indeed, the opportunities in this fast growing employment oriented sector are striking. But allowing greater FDI into these activities is fraught with policy restrictions.

New Areas for FDI

  1. As mentioned already, vast areas of services economy are beyond FDI. One such area is railways. Indian railways system is government run and private investment in core railway functions is not permitted. This has through not created a railway system which is ideally suited for a fast growing economy. Earlier, Rakesh Mohan Committee on infrastructure has recommended throwing up the entire railway sect open to private investment. The finance ministry paper (2010) suggests allowing 26 percent foreign investment in railways which can help overcome the current drought in investment in the railway. Liberalization and opening up to FDI can help in modernizing the railway system which is badly needed at present. Additionally, international linkages can allow Indian railways to tap niche areas like exporting railway services.

  2. Another areas of transport Industry, namely shipping services could attract FDI and take India to the status of a major maritime nation. Here, while there are no policy issues regarding FDI cap, domestic tax and rigid regulations like manning norms in India work ad deterrents to the foreign investor. India's shipping tonnage is inadequate, accounting for a meagre 1.17 percent of global registration. The tax structure on Indian shipping needs to be rationalized at the earliest so as to make investment in shipping services worthwhile.

  3. It is one of the challenges before India's services sector to broad base exports of services. Indian can make forays into globally traded services such as accountancy, legal services, healthcare and education services. The legal system in India, USA and UK are all rooted in British common law and this enables India lawyers to deal with legal businesses without much additional training. Preparing and reviewing legal documents, drawing up contracts and vetting these are some of the areas where India can be a very cost efficient outsourcing location. Already, ‘legal process outsourcing (LPO)’ has emerged as a new area. Unfortunately, there are laws strictly forbidding foreign law firms to enter the Indian law business space. As a result, Indian law firms also face similar disabilities in the UK or US markets. Mutual recognition of law degrees and access to each other's lawyers could open up this market for Indian law firms. In the same manner, healthcare and educational sectors could flourish through international linkages.

  1. Unless the service sector growth quickens, India cannot attain the professed double-digit growth target. The varied problems and challenges of the service sector will have to be resolved in this context. Attracting FDI and forging more effective international linkages are the key to this objective. If there are policy obstacles, efforts should be made to overcome these in other ways.


Courtesy: Yojana