The gravitational forces are changing. China attracted a lot of foreign direct investment which, along with exports, became the driver of its economic growth. India was late in bringing in reforms but has now reached that critical mass which will draw investment from abroad.
Last year, China received $72.4 billion (Rs 3,25,000 crore) FDI or about eight per cent of the global foreign investment. India was way down with investment of only about $7.7 billion - though this is an underestimate because it does not capture all the investment going through the automatic route.
Even so, the FDI India received would be less than a fifth of what China did. India, however, has been a more attractive destination for equity investment, which has been partly responsible for the boom in our stock markets.
Investors had a reason to go to China. It offered far better terms to foreign companies in comparison to domestic companies. The former, for instance, pay 12 per cent tax while the latter pay 25 per cent. The system of contract labour made employment flexible. These incentives were a great pull and investment poured in from Hong Kong, Taiwan, Japan, South Korea and the United States.
China does not need foreign capital now as it did earlier. It has accumulated foreign exchange reserves exceeding $1 trillion. Foreign investment, on the contrary, is now causing worry. That is because foreign investors control 21 out of 28 key manufacturing industries and are responsible for more than 60 per cent of China's exports. Chinese domestic entrepreneurship has been overshadowed by foreign companies.
It is no wonder China is now wanting to bring back the level playing field which was skewed in favour of foreign companies. The tax rates will no longer be lower for foreign companies. Termination of employment will have to be done in consultation with labour unions. Mergers and acquisitions will be permitted taking into consideration 'national economic security'.
Equally, there is frustration on the part of foreign investors. Not all foreign companies could make the grade. Only a third succeeded. There is now a downturn in FDI and it is quite possible that 2005 may have been the peak year for China for FDI.
What China loses India may gain. It is not necessary, unlike China, to offer incentives. All that is required is to create a level playing field for foreign investors. There is no reason why foreign companies should pay a higher tax. The room for foreign investment has to be enlarged by increasing the percentage of equity they can hold and the number of industries they can invest in. It is in that direction that the policy is moving.
The future direction of global FDI is likely to be different. While investment in China will decline in the absence of incentives it will increase in India because of better opportunities. Possibly, in another three or four years India may overtake China in FDI and consequently in the rate of growth, if our government plays its cards well.