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FII activity in the Indian security market includes investments in primary markets’ initial public offerings, mergers and acquisitions and trade in secondary markets. Investors in the West are happy to have India in their international stock portfolio.

FDI, in contrast, is brick-and-mortar money, which is used by India to build factories, infrastructure and real estate. This is important money, which stays in the country on a long-term basis. FII money has a tendency to take flight at the slightest hint of political or economic instability, while FDI stays in the country, as it is tied down to industrial, agriculture or other output. China is built on FDI, with little contribution from FIIs. India is building itself on a combination of both.

A third source of funds coming into India is remittances from abroad by non-resident Indians. In 2008 alone, overseas Indians remitted US$45 billion back home. Such remittances allow recipient countries to weather economic turbulence like the recent economic downturn. China is a distant second to India, with US$34 billion in remittances from abroad in 2008.

All of this means India is awash with cash. Where most developed Western countries are likely to show negative growth rates for 2009, India is predicted to show 6.5 percent growth. Its last quarter growth was 6.15 percent. The huge influx of funds is paving the way for better economic performance, although the late arrival of monsoons has not been factored into the growth forecasts and may shave off a percentage point or two.

With so much cash at its disposal, India need not draw much from its foreign exchange reserves. The cash is enough to counter the oil price spike in 2008 and finance development plans, with only a minimum of borrowing. A slower growth in foreign-held reserves is due to the recession in the West and the lackluster performance of exports.

FIIs should be watched carefully. Indices of the country’s stock market, the Bombay Stock Exchange, have risen dramatically since March as more money is poured in. The “feel good factor” in the stock market is inviting even to small investors. But they will suffer the most if FII money is withdrawn rapidly.

In late 2008, at the beginning of the economic bust, foreign investors withdrew some US$12 billion, which resulted in stock indices spiraling down. Still, their presence is more of a boon than a bust.

The billions of dollars flooding into India are not due to the Congress Party’s return to power in the recent general elections; they are related to global phenomena. World financial markets were paralyzed with fear since mid-2008, which began to recede as government stimulus packages began to show results. Since April, FIIs began to reappear, mostly in the emerging markets of Brazil, Russia, India and China. India’s stock market index rose 50 percent in three months. Other countries recorded even bigger rises. So, the dollar flood is not India specific; rather, it is a new dawn after a dark night as it moves into places that generate a better return on investment. India happens to be one such place.

Unlike other export-driven economies, India’s advantage is that it is a consumer-driven economy. FIIs rightly believe that ultimately local consumers will perk up the economy. This is an envious position. Only Western countries had that status for the last 100 years, as they called the shots in the markets they controlled.

By gutting manufacturing at home, Western countries have handed the keys to their economies to exporting nations. This will soon change with a period of structural adjustment that will settle down to balance manufacturing, exports, imports, cash flows, debts and finances appropriately.

It was not easy for India to convince FDIs to build factories in the country. China had been their focus since 1983 and investors in the West began to think of India only in 2005. Prior to that FDI in India was miniscule, averaging less than US$3 billion annually since 1995. Since then it is growing by leaps and bounds.

In 2006, it jumped from a mere US$7 billion to US$19 billion. In 2007, it stood at US$23 billion and in 2008 it jumped to an all-time high of US$47 billion. India is on the world’s development radar.

FDI is bringing technology, much-needed modern machinery and organizational skills. It is aiding the development of new manufacturing bases, contributing to higher productivity and improving quality to develop much-needed infrastructure. It is a lifeline to modern India. Alternate effects and spillover into other sectors of manufacturing will enable India to produce products to world standards.

One direct impact of FDI is the domestic real estate market. There is a huge gap in demand and supply of private housing and commercial real estate. In 2006, PricewaterhouseCoopers estimated that at least US$25 billion was needed immediately to relieve the extreme housing shortage in India’s big metropolitan centers, followed by US$10 billion every year for the next ten years. Still, the gap will be big, because as India urbanizes, demand for cheap housing will rise.

Power generation, building modern roads and rail infrastructure and upgrading port facilities will require about US$300 to US$500 billion over the next five to 10 years. This amount, although large, is within easy reach of foreign investors to finance. India intends to pay back every penny of it. Modern infrastructure is key to building quality industrial products to international standards. Besides, India also has cheap labor.

In comparison, China has been very successful in making a political deal before an economic one with the United States. Encircling the Soviet Union and the Cold War was at the heart of U.S. deal making. It took both China and the United States 10 years from 1975 to 1985 to reach an agreement, after which the FDI floodgates opened.

Within 20 years, everything old and outmoded in China was rebuilt. Concurrently the United States and Europe opened their markets to Chinese products, which has guaranteed prosperity to China in the last five years.

So the spanking new look of China’s eastern seaboard today is not due to China’s sole investment but rather has a huge FDI component. Presently, China can sustain itself, as more and more FDI is pouring in. This is a great modern-day economic miracle, which is uplifting China from its past two centuries of turmoil, foreign rule and political instability. India also needs the same.

If the current momentum of FDI, FIIs and incoming remittances is maintained, India’s gross domestic product growth could exceed the current target of 9 percent. By all standards, it is a very healthy growth. If you factor in the underground economy it is even healthier, although this does not enter official statistics.

The key to maintaining high growth is political and economic stability. Democracy and frequent elections help to maintain this stability.

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(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)