Foreign capital going. Can India lure investors back?

The inflow of foreign capital into India has slowed recently, raising questions about the country's ability to attract investors once more. While overall foreign direct investment in India remains robust, portfolio investment flows have become less predictable. This volatility stems from the fact that India now faces competition from a wider range of emerging markets, including the United States, East Asia, and developed economies vying for investment in the next wave of technologies and industries.

Portfolio investors have been particularly sensitive to recent global factors such as rising oil prices, increased US Treasury yields, and currency concerns. This has led to a significant outflow of funds from Indian equities, with investments falling to $26.75 billion by mid-September. While this represents a substantial decrease, it does not indicate a complete loss of faith in India's market. Instead, many investors are simply shifting their attention to other opportunities.

One major reason for the shift is the AI investment boom, which has diverted capital towards markets like Taiwan and South Korea. These countries are perceived as offering greater direct exposure to semiconductor and AI infrastructure sectors. Consequently, India must rethink how it can compete in the tech investment cycle and present a compelling story to foreign investors.

To attract capital back to India, the country needs to upgrade its investment story and focus on offering businesses that can compete globally. Simply relying on the size of the domestic market is no longer sufficient. India must move beyond this narrative and demonstrate that it can provide investors with access to globally competitive industries. This transition requires a more focused industrial policy that emphasizes competitiveness over general business-friendly policies.

India has made progress in the semiconductor sector, attracting around Rs 1.34 lakh crore in equity funding. However, merely having successful individual projects is not enough. Investors require a comprehensive ecosystem, including suppliers, skilled workers, reliable power, efficient logistics, and predictable access to imported components. Addressing structural issues related to land and labor regulations, tariffs, and bureaucratic procedures is crucial for nurturing a robust manufacturing sector.

Policy certainty is essential for attracting foreign investment. Investors are increasingly wary of high wages, expensive real estate, and currency risks. What they find more challenging to predict is the level of uncertainty surrounding taxes, regulations, and rule interpretations. Simplifying rules for offshore investment funds and providing greater tax certainty can help alleviate these concerns. Nevertheless, sustained high-quality, consistent, and relatively swift decision-making is critical in reassuring investors.

Foreign investors must also evaluate a country's credibility based on its actions post-investment. Frequent changes, retrospective disputes, or unclear administrative decisions can undermine the attractiveness of even the most promising incentive packages. Similarly, reliable dispute-resolution frameworks are vital. Foreign investors are deeply concerned about India's requirement to pursue remedies in Indian courts before accessing international arbitration.

The ability to resolve disputes efficiently and effectively is nearly as important as the tax rate when making significant investment decisions.

In conclusion, India must reconsider what "business-friendly" truly means in the context of attracting foreign capital. While being business-friendly may involve offering select incentives or relaxing particular rules, a more competitive economy that encourages many companies to enter, compete, scale, and challenge incumbents is crucial.

Simpler compliance, faster approvals, and minimal arbitrary barriers are key components of this approach. Most importantly, India must resist the temptation to protect domestic producers too aggressively, as this can hinder foreign companies from establishing efficient supply chains in the country. By prioritizing competition and creating conditions that enable numerous businesses to thrive, India can enhance its appeal to investors during the next tech investment cycle.