The Wonders of FDI | Episode 111 | Everything is Everything

Notes

Intro: the many loves of Ajay Shah's life

Amit opens by teasing that this episode, despite its title, is not about money but about love. Ajay confides that he has five great loves in his life, and FDI is only the fifth. When pressed to name the other four, he offers firm productivity, capital account openness, inflation targeting, and R programming, each delivered with the same theatrical fervor Amit invites for FDI itself.

The playful frame gives way to a real anecdote. Ajay recalls his first brush with FDI as a child in the early 1980s, before his father passed away in 1984. An American visitor from Corning Glass came to meet his father, hoping to set up a factory in India to manufacture glass for television picture tubes. Ajay's father told the visitor plainly that the Indian state would not allow it, that the activity was banned. The American was baffled that a government would actively prevent factories from being built.

Amit connects this immediately to a larger theme:

"And it's actually a brush with freedom as well, because ultimately that's what it boils down to. What you really love is not FDI. FDI is just one name. What you love is freedom, isn't it, Ajay?"

Ajay refines this further, framing his real love as "the freedom to engage in domestic investment," setting up the episode's central argument that FDI is really a story about institutional freedom, not just foreign capital.

What is FDI?

Ajay starts with the intuitive definition: a foreigner builds a factory to operate in India. But he pushes past this to the technical definition. FDI is a foreigner having a substantial and long-term stake in an Indian production arrangement. The OECD and IMF standard sets the threshold at ten percent equity shareholding; below that, an investment is counted as portfolio investment rather than FDI, even if the investor has real influence.

He gives a concrete example: if a foreigner buys and quickly sells shares in a company like Britannia, that is foreign portfolio investment. But a significant, long-term equity stake with real involvement in company affairs is FDI. Foreign loans to Indian subsidiaries also count as FDI, since debt financing between a parent and subsidiary reflects the same kind of long-term engagement as equity.

The conversation also introduces directional terminology. "FDI in India" refers to foreign activity inside India, while "FDI by India" refers to Indian firms investing abroad, such as Cafe Coffee Day's operations in Vienna. Ajay flags two subtleties that complicate the picture. First, private equity investments above the ten percent threshold get classified as FDI even when they behave more like arms-length financial investments, raising questions about whether such stakes are "truly" FDI in the spirit of the term. Second, profits earned by foreign operations in India can either be reinvested, in which case they count as fresh FDI inflow for that year, or repatriated abroad, in which case they show up as an outflow.

Measuring FDI

Ajay walks through how the balance of payments captures FDI through what he describes as trusted, high-quality data. For FDI in India, there is a gross inflow and a gross outflow, the latter reflecting repatriation by foreign firms sending profits home; netting these two gives net FDI in India. Symmetrically, FDI by India has its own gross outflow, as Indian companies invest abroad, and gross inflow, as those foreign operations send money back to India; netting these gives net FDI by India. Finally, combining both directions produces what Ajay calls, only half-jokingly, a "net-net" FDI figure.

This adds up to seven distinct series in total: two gross flows for FDI in India, two gross flows for FDI by India, two net figures, and one net-net figure. Ajay's concern is that this richness of data becomes a tool for manipulation.

He states his position bluntly:

"This is used to cherry-pick a message that propagandists want. So, when a propagandist wants to make India look good, they will look at this entire landscape and pick a number that makes India look good, and vice versa."

His test for spotting this manipulation is simple but sharp: if someone labels a chart or table simply "FDI" without specifying which of the seven series they mean, they are very likely engaged in propaganda rather than precise communication. He insists that responsible communication requires specifying gross inflow, net inflow, or net-net explicitly, since each series carries its own message and interpretation, and none should be cherry-picked to serve a predetermined narrative.

The dream of FDI

This chapter forms the intellectual core of the episode. Ajay describes the "dream" of FDI as a hack for countries with dysfunctional institutions. The idea is to carve out a limited zone, perhaps a single square kilometer, where a factory can operate free from the normal depredations of the local state: no local labor law enforcement, no tax harassment, no visa friction, no customs duties or tariff barriers on goods moving in or out.

He frames this as requiring real honesty from a country's leadership:

"That is the dream of FDI, that we recognize that we are malfunctioning as a country. One day we'll fix our country. In the short term, I'll just create this as a hack."

Ajay credits Deng Xiaoping's China as the model that understood this clearly. Deng's implicit dream, Ajay argues, was that China would eventually fix its own institutions, but that this would take too long to wait for. So China built a genuinely trusted, predictable institutional interface specifically for foreign investors, meaning FDI into China operated under good institutions even while the broader Chinese economy operated under weaker ones.

This is not, Ajay insists, an unfair arrangement that should trouble us morally. The state benefits pragmatically: workers get jobs, their wages generate income tax, and their spending generates GST, while the state deliberately backs off from any other claim on the foreign operation. Beyond the immediate fiscal benefit, Ajay identifies the deeper prize as knowledge diffusion. Workers inside foreign operations learn frontier production techniques and global business practices, and that knowledge does not stay locked inside the foreign firm. Workers move to other jobs, start their own businesses, and diffuse what they've learned through the wider economy. He cites Bangladesh's garment industry, where Taiwanese and South Korean firms first brought in production know-how that later spread as workers left to start their own operations.

Ajay also introduces the concept of a bonded warehouse: a physical facility where imports enter fully exempt from state interference, get processed into finished goods, and exit back into the world market. He considers this one of the cleanest illustrations of the enclave principle.

He argues India never articulated this bargain honestly enough:

"We want FDI to succeed because the Indian state works badly. If the Indian state was fine, then domestic firms would have done great. We would have been an advanced economy."

As a cautionary counterpoint, Ajay notes that even China's own model began to break down under Xi Jinping, who reintroduced the very depredations the enclave model was designed to prevent, including forced technology transfer, mandated joint ventures, and required local IPOs. This reversal of institutional clarity, he argues, is directly connected to a subsequent collapse in FDI into China.

Amit connects this discussion to two earlier episodes in the series, one on internationalization (I18N) and one on populism, arguing that toxic insular nationalism, expressed through slogans like "Make in India" or import substitution, works directly against the logic of FDI that Ajay has just laid out. Ajay responds by describing a deep anti-foreigner and anti-Western streak in India, layered with what he calls a "cult of third-worldism" that treated multinationals as inherently hostile, alongside a contradictory arrogance in the modern period that assumed India's market size meant no need to accommodate foreign companies at all. As a concrete illustration of the cost of this failure, he points again to Nokia, whose Tamil Nadu facility was hit with tax action and asset freezes by the Indian state until the company eventually left the country entirely.

Amit adds an important clarification here, noting that the argument is not against fixing Indian institutions broadly:

"The thing is that that is so messed up and it's been so complicated for decades that it's going to take a long time to fix. Ajay has literally spent his whole life fighting that battle. So that battle will continue. But in the meantime, if you can at least set up these little islands of freedom, as it were, then that's good for the people."

What about Foreign Portfolio Investment?

Ajay turns to what he considers a widespread analytical error in Indian policy thinking: the belief that FDI is virtuous while FPI is dangerous "hot money." He attributes this hostility to insecurity, arguing that a country afraid of its own weakness fears that portfolio investors, who can buy today and sell tomorrow, might abandon it overnight.

He dismantles this view on two grounds. First, foreign investors already know about India's institutional weaknesses, and this knowledge gets priced into securities as a lower valuation rather than triggering instability. Second, financial markets involve tens of thousands of buyers and sellers acting independently, not a coordinated monolithic bloc

Ajay states this plainly:

"We don't have to anthropomorphize foreign investors as one monolithic block that thinks together, acts together, FPI Inc, where they all coordinate their strategies. This is just completely wrong."

He points to India's own data as evidence: large gross buying and large gross selling happen simultaneously every day, netting out to small figures, and India has never experienced a genuine crisis driven purely by foreign portfolio exit. Episodes like the COVID lockdown produced broad selling by both Indian and foreign investors alike, with nothing distinctly foreign about the behavior.

The more surprising argument comes next. Ajay flips the conventional hierarchy, arguing that FDI actually demands a lower institutional bar than FPI. For FDI, the ask is narrow: deregulation, a "simple API" that gets the state out of the way for a bounded enclave. For FPI, by contrast, a foreign investor sending money to buy shares needs to trust a much deeper institutional stack, including reliable accounting, functioning depositories, honest audits, and a stock market with a long track record. He describes this as requiring "that hundred years of culture of decency in accounting."

He credits Ila Patnaik with recognizing this dynamic clearly, and closes with the observation that China, despite its FDI success, never built the accounting and institutional infrastructure needed to support foreign portfolio investment at the same level India has, thanks to India's much longer tradition of accounting practice.

The political economy around FDI

Ajay shifts to explaining why, despite the clean economic logic, FDI faces political resistance in India that FPI often does not. The key difference lies in who benefits and who loses locally. An FDI enclave that simply exports goods produced in India creates little domestic friction. But a foreign firm that also wants to sell into the Indian market directly competes with existing domestic businesses.

He gives a stark example: if a foreign automaker builds cars in India to compete with Premier Padmini, that is bad for Premier Padmini specifically, even if it benefits Indian consumers broadly. This creates opposition from the Indian business establishment, visible in more recent controversies around Amazon and Walmart's presence in Indian retail.

By contrast, FPI faces no such resistance from Indian business, because a foreign investor buying shares in an Indian company lowers that company's cost of capital, a straightforwardly beneficial outcome for the Indian corporate class. Ajay summarizes the asymmetry as a matter of unfinished intellectual work in India: the country never achieved the clarity needed to build a genuine SEZ-style enclave model, despite the SEZ Act of 2005, because the deeper logic of immunizing foreign firms from Indian institutions was never fully understood or embraced.

Amit crystallizes the contrast with a pun that closes the chapter:

"On one side of the debate you have securities, on the other side you have insecurities."

Tariff-jumping FDI

Ajay introduces Jagdish Bhagwati's phrase "tariff-jumping FDI" to describe a distortion that arises when trade barriers exist. Rather than genuinely engaging with India as a production base for domestic or global markets, some foreign firms simply build minimal facilities in India purely to bypass tariff and non-tariff barriers. He gives the example of semi-knock-down car assembly, where a foreign automaker does only the minimum value addition required inside India to sell into the protected domestic market.

Ajay considers this outcome unsatisfying, since it represents arbitrage around policy rather than a genuine embrace of either the enclave model or full market integration. He connects this back to the broader argument from the EIE episode on Indian manufacturing, noting that trade barriers on raw materials, such as duties on imported artificial fabric used in garment manufacturing, raise input costs and directly undermine the competitiveness of Indian exports like shirts in global markets.

His conclusion is that trade liberalization is a precondition either way: either a country commits fully to the enclave model, with genuinely zero friction at the border, or it commits to open FDI integrated with the domestic market, in which case ordinary trade barriers should not exist either. As long as trade barriers persist in India, tariff-jumping FDI will continue as a second-best distortion rather than a genuine embrace of either coherent model.

Building the right environment

Amit raises a pointed challenge: if the Indian state is fundamentally prone to expropriating its own citizens, how can foreigners be protected from the same treatment, and how can predictability be established after episodes like Pranab Mukherjee's retrospective taxation of Vodafone?

Ajay's answer centers on bilateral investment treaties (BITs). Under a BIT, the Indian state signs an agreement with an OECD country's government promising to compensate private investors if the Indian state engages in expropriatory behavior, regardless of whether the misbehavior originated with the union government, a state government, or a city government. He acknowledges this is a startling admission for a government to make, essentially committing in advance to pay for its own future misconduct.

He frames the payouts as a rational cost of doing business:

"We should see that drip of payouts on account of BITs to be like an insurance premium that I'm stabilizing hundred billion dollars of FDI into India. I'm paying out one billion dollars a year. It's a good deal."

However, Ajay notes that frontline Indian officials have historically resented these payouts, treating lost cases as personal career setbacks or departmental budget failures rather than a reasonable national cost. He connects this resentment to a broader arrogance in Indian policy circles that treats the sovereign right to expropriate as sacrosanct, rather than as something the country should submit to institutional discipline. He traces a decline from the relatively favorable 1991 to 2011 period, through the introduction of a much weaker model BIT in 2016 that abandoned many of these protective ideas, to a present-day India increasingly hostile to signing new bilateral investment treaties altogether.

He closes with a reframe of the entire dynamic as incentive-compatible rather than humiliating:

"It is very good to get slapped because that is the only way you will create these checks and balances. So I actually think it's a great commitment device whereby the Indian state says, look, I am a poor country, I'm a third world country. I'm gradually trying to make my institutions better. Every now and then we will fumble, we'll make mistakes, and at that time, I will get slapped in the face."

Raju Ban Gaya Gentleman

Amit references the film title playfully to introduce the flip side of the FDI story: Indian firms themselves becoming global multinationals. Ajay describes this as a striking reversal of old third-worldist assumptions, which imagined developing countries only ever as passive recipients of foreign capital, with helpless local workers exploited by foreign factories.

He introduces the Helpman-Melitz-Yeaple (HMY) model as the standard framework for understanding this progression: the weakest firms remain purely domestic, stronger firms graduate to exporting, and the highest-productivity firms graduate further to become genuine multinationals conducting outbound FDI. Ajay co-authored an early paper on this phenomenon in the Indian context with Dilek Demirbas and Ila Patnaik, titled "Graduating to Globalization."

He then highlights a specific and important exception uncovered in his own research: the Indian software industry inverts the standard HMY hierarchy. Because "FDI" in Indian software often takes the form of body-shopping, where firms physically place workers onshore in client countries like the UK or Germany, these FDI-classified operations are often less productive than purely domestic Indian software companies serving foreign clients remotely. Ajay and his co-authors published a paper specifically on this reversal of the HMY model for Indian software.

Amit and Ajay close the chapter with a lighthearted aside about the podcast itself functioning as an "exporting show," given its international audience, half in jest but underscoring the same underlying idea that graduation from domestic to export to global status is a meaningful marker of quality, whether for firms or for other forms of Indian output.

A remarkable opportunity for India

In the closing chapter, Ajay steps back to make a broader historical claim. He argues that the world is currently experiencing major disruptions, including the breakdown of the China FDI model under Xi Jinping and disruptions from United States tariff policy, and that these combined shifts create what he considers a remarkable opportunity for India.

He is careful to qualify this claim, noting that the opportunity has not yet materialized in the data:

"It is not yet in the data. We are not seeing a great surge in either FDI or goods export from India, but I deeply believe that the conditions are right for things to change in India now."

Ajay frames 2025 specifically as an important moment in India's history, one he believes deserves close attention given its potential to serve as an engine for Indian economic progress. Amit closes the episode by acknowledging the uncertainty in Ajay's optimism, noting that even if this particular opportunity does not fully materialize, the broader project of institutional reform in India remains a long game that the two of them, and the podcast itself, will continue to track.

Supplementary Resources

• Graduating to globalisation: a study of Southern multinationals by Dilek Demirbas, Ila Patnaik and Ajay Shah (Journal article)
• Strategy for FDI by Indian firms: A 2x2 classification for the leadership by Ajay Shah (Resource)
• The reconfiguration of global trade and FDI by Ajay Shah (Resource)
• How to get a 10x gain in FDI by Ajay Shah (Resource)

The complete transcript file is available to download below.