Commonwealth Games: Best and worst of times for India to attract foreign capital

Stock is up, but foreign direct investment is down

On the one hand, Mumbai's (Bombay's) SENSEX stock exchange is reaching all-time highs as a flood of cheap money from developed nations seeks out the high growth rates of developing economies like India.

But foreign direct investment – or the opening of factories and other business ventures on Indian soil – is down by nearly a quarter to $12.6 billion in the first seven months of 2010. The decline cannot be blamed entirely on the global economy: China's FDI jumped 21 percent to $58.4 billion over the same period.

Why the schizophrenia? Prasad points to the poor reputation of India's government versus the attractiveness of its private sector.

To open a factory anywhere requires a lot of interaction with the government: securing land rights, acquiring permits, and paying taxes. In India, that means dealing with a country ranked 133 out of 181 by the World Bank for ease of doing business.

That prospect terrifies investors, who decide instead to buy stock in Indian firms in order to tap into the country's red-hot 8.5 percent growth. The games may only reinforce this.

"One likely effect of the Commonwealth Games is not a shift in the volume of [foreign investment] inflows, but in the composition of the inflows: away from FDI and toward equity flows," says Prasad.

FDI is preferable because it brings with it technology transfer and a longer-term commitment to see through projects than fickle equity investment often provides.

India needs FDI to help upgrade its inadequate infrastructure. A report in April from the McKinsey Global Institute found that the country needs to spend $1.2 trillion on its cities over the next 20 years in order to handle rapid urbanization. Despite the massive needs, business experts at an investment summit last month said foreign investment would play a secondary role in bridging the infrastructure gap due to the difficulty of pulling off projects in India.

Research by Andrew Rose, a professor of international business at the University of California in Berkeley, has found a permanent "Olympic trade effect."

Countries that host – or seriously bid for – Olympics and other major international events can see a large boost down the road in import and export volumes, he says. But it's not known yet if investment also jumps.

"Because these bids are commonly followed by moves towards [economic] liberalization, it seems logical that the action of attempting to become a mega event host sends a signal that a country wishes to liberalize trade," write Dr. Rose and coauthor Mark Spiegel.

Rose suspects India will not see significant gains from the games because the country has already undergone significant trade liberalization.

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