India's FDI Paradox: When capital inflows hit a record high, net investment nearly dries up.

India's FDI Paradox: When Capital Inflows Hit Record Highs, Net Investment Nearly Dries Up

In FY 2025-26, India attracted a record $94.6 billion in total foreign direct investment (FDI) inflows, but net FDI after adjusting for outflows stood at only $7.6 billion—down over 80% from the peak of $44 billion in FY 2020-21. This gap has raised market doubts about the sustainability of India's investment. The divergence between superficial prosperity and underlying weakness cannot be explained simply by profit repatriation.

Deconstructing FDI: Three Capital Categories That Are Not Alike

Conventional wisdom views FDI as long-term, stable productive capital, but the structure of FDI flowing into India has undergone fundamental changes. Data from the Reserve Bank of India shows that during FY 2022-23 to FY 2025-26, only 41.9% of effective FDI inflows truly represented "real FDI" from multinational enterprises bringing technology, brands, and production capacity; financial investors such as private equity, venture capital, and sovereign wealth funds contributed 40.5%; and diaspora investment and special purpose vehicles (SPVs) accounted for 17.6%.

The investment logic of financial investors differs fundamentally from that of industrial capital: their core objectives are capital appreciation and planned exits. A typical example is Singapore's Temasek's exit from Schneider Electric's India operations in 2025, converting a $637 million investment into $6.4 billion within five years. Throughout 2025, just 45 large PE/VC exits generated $29 billion in capital outflows, accounting for over 55% of the total $52 billion in divestments that year. This means that a significant portion of the inflowing "FDI" is essentially hot money, not patient capital for building factories.

Persistent Shrinkage of Manufacturing FDI: A Structural Concern

If the dominance of financial investors in FDI inflows brings short-term volatility, the continuous decline in real manufacturing FDI strikes at the root of long-term competitiveness. India's real manufacturing FDI has fallen consecutively over the last two four-year cycles. During FY 2022-23 to FY 2025-26, manufacturing accounted for only 10.6% of effective total inflows. This stands in sharp contrast to India's "Make in India" strategy.

In comparison with Southeast Asia: Vietnam's manufacturing FDI accounted for about 60% of total inflows in 2023, while Indonesia's downstream nickel industry attracted substantial processing plant investments. In the wave of "China+1" global supply chain restructuring, India has not emerged as a major manufacturing absorber as expected. Reasons include difficulties in land acquisition, rigid labor regulations, and infrastructure bottlenecks—although improvements have been made in recent years, India's cost and efficiency advantages in manufacturing have not yet been fully realized relative to competitors like Vietnam and Thailand.

Panorama of Capital Outflows: For Every $1 Inflow, $1.5 OutflowThe direct cause of the sluggish net FDI is the sharp expansion of capital outflows. If we sum up divestment, dividend repatriation ($118.9 billion), and intellectual property royalties ($46.6 billion) (excluding outward FDI and technical service fees), total outflows during FY2022-23 to FY2025-26 reached $344.4 billion. Over the same period, new inflows (excluding reinvested earnings) stood at $230.6 billion. This means: for every $1 of FDI inflow, approximately $1.5 flows out in various forms.

This ratio has been deteriorating at an accelerating pace: $0.56 in 2014-18, rising to $0.70 in 2018-22, and now exceeding $1.50. The widening capital outflow gap puts pressure on India's balance of payments, especially against the backdrop of high global interest rates and tightening financing conditions for emerging markets.

The Puzzle of Outward FDI: Capital Recycling or True Globalization?

India's outward foreign direct investment (OFDI) has also risen rapidly, reaching $65 billion cumulatively from FY2023-24 to FY2025-26. However, 45% of this flowed into "financial, insurance, and business services," primarily to Singapore (27%) and the UAE (11%). A large amount of capital enters these jurisdictions through holding companies and SPVs, rather than being invested in operational businesses. A typical example: Tata Motors' subsidiary injected $405 million into an Italian company through a Singapore entity. India's domestic GIFT City further blurs capital flows: OFDI via GIFT City surged from $246 million to $1.18 billion. This "round-tripping" capital flow distorts the actual investment picture, reflecting cross-border tax arbitrage and capital recycling rather than a genuine enhancement of Indian enterprises' global competitiveness.

Policy Implications: Beyond the Obsession with Aggregates

India's Chief Economic Advisor defends the investment climate using strong gross inflow data, while critics focus on the sharp decline in net FDI. Both miss the essence of the problem — the quality of FDI matters far more than quantity. To bridge the gap between gross inflows and net investment, India needs to make efforts in three areas:

1. **Optimize FDI Structure**: Guide through industrial policies to attract genuine FDI in manufacturing, R&D, and high-end services, while reviewing reliance on financial investors (especially short-term capital entering through tax havens). 2. **Reduce Capital Outflows**: While simplifying profit repatriation and divestment processes is expected of an open market, efforts should be made to reduce current account outflows such as intellectual property royalties, and reduce external dependence by strengthening indigenous innovation capabilities. 3. **Improve Local Business Environment**: Enhance flexibility in land and labor markets, accelerate infrastructure construction, and reduce logistics costs to truly attract manufacturing multinationals that require long-term presence.

At a time when global FDI is undergoing geopolitical-driven supply chain restructuring, India possesses a vast domestic market and digital economy advantages. However, if it cannot convert aggregate prosperity into net capital retention and industrial upgrading, the so-called "FDI miracle" will be nothing more than a fleeting illusion.*This article is based on the net FDI analysis report released by Vajiram & Ravi and data from international investment institutions.*