India’s perspective on investment and exports has become more unified over the past decade. India has integrated three key policy threads: liberalising FDI, enhancing industrial policy through PLIs and sector-specific schemes, and safeguarding overseas market access via trade agreements. Overall, the intent seems clear: attract businesses from across the globe, boost manufacturing in India, and secure a more prominent position in global value chains (GVCs).
It makes sense to do all three. FDI brings capital and production capacity. Industrial policy can incentivise investment where India wants to gain scale. Trade agreements can open markets for firms exporting from India. But while foreign investment is important, ultimately success will be judged by what happens after capital arrives in India.
To understand this, it is useful to look at India’s track record on manufacturing.
In a new study, we analyse how FDI has impacted India’s manufactured exports over twenty years across its major export destinations. On balance, we find that foreign investment has contributed to exports. The mechanism through which this impact occurs, however, warrants closer consideration. Rather than through wider technology and knowledge spillovers that multinational firms may generate, the evidence points to an expansion of productive capacity as the primary driver.
FDI can contribute to exports through two channels. The first is capital formation. Investment enables additional factories, machinery, and productive capacity. By easing supply constraints, this allows firms to produce more for both domestic and export markets. The second channel is through spillovers. Multinationals bring with them technology, managerial practices, production standards, international contacts, and knowledge of foreign markets. Domestic firms may benefit from spillovers if they learn from foreign companies, sell to them as suppliers, or participate in global value chains with their help.
The evidence suggests India has experienced more of the former than the latter. Put simply, FDI has helped India build productive capacity, but technology, knowledge and exporting know-how have not diffused to Indian firms as much as expected or hoped.
This has policy implications. Welcoming a multinational firm to India is only the beginning. Domestic firms must be equipped to link up with foreign investors. If an international company is producing goods in India, it doesn’t necessarily follow that it will source inputs from Indian companies. Such firms may choose to import a majority of their inputs. They may have limited local suppliers. Domestic suppliers, especially smaller companies, may lack the scale or technology to meet international quality standards, or may not have workers with the necessary capabilities needed to become suppliers to multinational firms.
When foreign companies don’t link up with local firms, neither do the full gains from FDI.
The challenge for policymakers in India today is not only to attract investment, but also to ensure that it takes root in the domestic economy.
FDI policy should be accompanied by supplier development programs. Indian firms need support to upgrade their technology, meet international quality standards, improve their managerial practices, and train workers. Mapping local suppliers can help multinational corporations find Indian companies with the necessary capabilities. Cluster based programmes can connect foreign firms to domestic manufacturers. Testing, certification, and R&D support can serve as tools for smaller companies to establish their standing as suppliers to large international corporations. India’s trade agreements operate under comparable dynamics. While securing market access proves helpful for India, for Indian companies to succeed, they must demonstrate the ability to scale production, adhere to quality benchmarks, and compete on price. Thus, the necessity arises for trade, industrial, and FDI policies to be recognized as complementary. It’s the combined strength of the three that will ensure success.
India has advanced significantly in recent years to establish itself as a desirable location for international investment. Moving forward, the focus should shift from the quantity of FDI India attracts to the outcomes and utilization of that investment after it is received.
Judging India’s FDI policy by its success in bolstering the domestic economy leads us to ask a different set of questions. Does the volume of goods and services acquired by foreign companies from Indian firms grow each year? Are Indian suppliers getting more productive? Are they learning to adopt new technology? Are Indian companies moving into higher value added manufacturing? Are Indian firms becoming exporters? These questions matter because FDI’s long-term contribution doesn’t rely only on the factories multinational corporations build. It also depends on the ecosystem of capability that develops around those factories.
If India wants to increase its share of global manufacturing and exports, foreign investment must help it build a competitive manufacturing ecosystem, and not just a manufacturing destination.
