FDI in India: how much, where, and in what?

India’s foreign direct investment (FDI) performance continues to lag behind expectations, particularly when compared with China. Historically, FDI has been far more central to China’s growth model, accounting for a significantly larger share of gross domestic product (GDP) and investment. At its peak, foreign-invested enterprises contributed over 50% of China’s trade, 30% of manufacturing output, and 22% of manufacturing profits.

In contrast, India has relied more heavily on domestic savings. Even during periods of rapid growth, FDI never reached comparable levels. Although there was optimism that India could attract greater inflows as China’s appeal waned, this shift has not materialized at scale. The gap reflects structural issues in India’s investment climate rather than temporary cyclical factors.

Measured in absolute terms, FDI into India has increased over time, with inflows in recent years exceeding those before the 2008 global financial crisis. However, relative to GDP, FDI has stagnated for more than a decade. By 2018, FDI accounted for just 5.1% of gross capital formation, only a marginal improvement over two decades.

Even during recovery periods, FDI has hovered around 1.5%–2.0% of GDP. This suggests that while headline numbers may appear encouraging, FDI has not become a transformative force in the broader economy. India continues to capture between a quarter and a third of FDI flows to its peer group of emerging economies, but this share has not expanded significantly despite favorable global conditions.

The origins of FDI into India reveal additional complexities. A substantial portion flows through low-tax jurisdictions such as Singapore, Mauritius, and the Cayman Islands, raising concerns about “round-tripping,” where domestic capital is routed back into India to take advantage of tax benefits. This implies that actual foreign investment may be lower than official figures suggest.

Geographically, FDI is highly concentrated within India. Most inflows are directed to a handful of states clustered in three economic corridors: the Delhi region in the north, Maharashtra-Gujarat in the west, and a southern belt including Karnataka and Tamil Nadu. Only seven regions receive most of the investment, leaving much of the country with minimal exposure.

State-level competition often revolves around headline-grabbing investment announcements that fail to materialize, reflecting a focus on short-term political gains rather than sustained capital inflows.

A central disappointment lies in the sectoral composition of FDI. Despite strong political messaging promoting manufacturing — captured in Prime Minister Narendra Modi’s high-profile “Come, make in India” invitation — investment has overwhelmingly flowed into services rather than industry.

This divergence is significant. Manufacturing is widely viewed as critical for job creation and long-term development, particularly in a labor-abundant economy. Yet it has underperformed even by India’s modest FDI standards. The same constraints affecting manufacturing, including regulatory uncertainty, land acquisition challenges, and labor issues, are likely to impede investment in other capital-intensive sectors, such as those tied to sustainability.

Risks, returns, and narratives

Investor behavior in India reflects a rational response to risk. Financial investments, particularly in equity markets, are well protected by strong regulation, transparency requirements, and liquidity. Exiting such investments is straightforward.

In contrast, direct investments in infrastructure, manufacturing, or energy expose investors to multiple layers of risk: regulatory unpredictability, weak contract enforcement, and political interference. India ranks 13th globally in protecting minority investors but 163rd in contract enforcement, illustrating the stark contrast between financial and real-sector investments.

A key complication is the definition of FDI itself. Since 2013, any foreign investment exceeding 10% ownership in a listed company is classified as FDI, blurring the line between long-term productive investment and financial transactions. As a result, headline FDI figures often reflect mergers, acquisitions, or large equity purchases rather than new projects on the ground.

High-profile failures have further shaped investor perceptions. Cases involving telecom firms, energy companies, and large industrial projects have resulted in massive losses due to policy reversals, legal disputes, or government actions. These experiences have reinforced fears of “catastrophic” capital loss, a risk that deters investment in sectors requiring large upfront commitments.

Rhetoric and reality

India has undertaken several reforms to improve its FDI climate, including simplifying approval processes and relaxing foreign ownership caps across sectors such as defense, insurance, and infrastructure.

However, these efforts have been undermined by contradictory policies. Regulatory uncertainty persists, particularly in sectors like e-commerce, where rules have been repeatedly revised in ways perceived as favoring domestic firms. Such actions create an unlevel playing field and discourage long-term commitments.

More significantly, India has withdrawn from many bilateral investment treaties and introduced new frameworks that offer weaker protections for foreign investors. This shift has been associated with a 14%–28% decline in FDI inflows. At the same time, the government has resisted implementing international arbitration rulings, further eroding investor confidence.

These inconsistencies highlight a gap between pro-investment rhetoric and on-the-ground realities. Without credible enforcement mechanisms and stable policies, reforms have limited impact.

A sustainable future?

The implications for sustainable finance are stark. Climate-related FDI into India remains minimal, estimated at US$1 billion annually in 2018–2019, or about 1% of total FDI. Most of this investment is concentrated in clean energy, particularly solar and wind.

Domestic financing dominates sustainable investment, with foreign private capital playing a minor role. This imbalance reflects the same risk dynamics observed in manufacturing and infrastructure. Power purchase agreements are often undermined by financially weak state utilities, delayed payments, or outright contract renegotiation. In some cases, political changes at the state level have led to governments reneging on existing agreements.

The broader lesson is clear: sectors critical to sustainable development share the same vulnerabilities as traditional FDI targets but often require even larger, front-loaded investments. Without addressing institutional weaknesses, particularly in regulation, dispute resolution, and political stability, India is unlikely to attract the scale of sustainable finance it needs.

The experience of FDI in India underscores a central challenge: ambition alone is insufficient. Aligning policy, institutions, and investor protections with stated goals will determine whether India can translate its growth potential into sustainable investment flows.

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