Why Indian States Need to Focus on Electricity Infrastructure to Attract FDI

Shashank Shekhar Rai & Francesca Pia Vantaggiato

 

In recent years, India has been one of the most sought after destination for Foreign Direct Investment.  However, the foremost evident characteristic of FDI inflows across Indian States is their astonishing skewness wherein two Indian States (Maharastra and Delhi) accounted for over 50% of total FDI into India for the period 2008-2012, while the biggest share of FDI inflows between 2000 and 2011 has been in the services and telecommunication sectors. Prior research has found that Net State Domestic Product (NSDP) per capita, population density, labour wages and literacy levels, all matter for explaining the flow FDI across Indian States.

Furthermore, the broader theme of infrastructure quality in developing countries is particularly relevant in the case of India. The presence and the quality of infrastructure impact FDI both directly and indirectly. The direct impact of infrastructure on FDI relates to the fact that it facilitates transportation, communication and operation, so that investors will not have to provide for those. The indirect impact of infrastructure on FDI, we contend, relates to the fact that infrastructure impacts on the overall economic well-being of the population, facilitating economic activity and thus growth. These, in turn, raise their purchasing power, rendering the country more attractive to foreign investors.

The quality of infrastructure in India is, overall, less than satisfactory. This is particularly true for electricity infrastructure, often described as a nightmare for consumers and a major bottleneck for India’s continuing growth. The availability and the reliability of electricity are understandably crucial to the practice of virtually all kinds of business. Clearly, energy-intensive industries (such as manufacturing) are likely to be sensitive to the costs of electricity in the country. If infrastructure is not reliable, but the cost of electricity is relatively low (or is kept low by agreement with government), however, manufacturing companies can relatively easily resort to own generation and/or finance own connections to generation plants.

The recent trend towards increased FDI in the services sector (such as telecommunication technologies, banking, etc.), however, points to the importance of both the availability and reliability of infrastructure (telecommunications and electricity) for business that would not normally have the incentive or the capability to bypass existing infrastructure and provide for its own energy needs. We find major obstacles for most states as electricity demand goes largely unsatisfied, load shedding is regularly practiced, and electricity losses frequently reach levels above 50%.

Meanwhile, FDI inflows have markedly increased since the year 2000 and have been mostly directed towards the services sector. However, growth in services sector provision presupposes the availability of decent and reliable energy services. Hence, we argue that FDI inflows are closely related to electricity infrastructure quality proxied by electricity grid losses as a percentage of electricity availability. We use electricity grid losses to proxy for infrastructure quality because these are likely to be most directly correlated to power outages, interruptions of service and to the general quality of service provision. Moreover, electricity grid losses are a proxy for the financial expenditure that would be needed to reduce them and that distribution companies do not make because they cannot afford it. In turn, the higher the losses, the higher governmental subsidization of distribution companies and electricity bills is likely to be; this may tell us something about the quality of governance in an area, another factor of importance to FDI.

In this paper, we investigate the role played by electricity infrastructure in attracting Foreign Direct Investment (FDI) to Indian States. We find that the hugely skewed distribution of FDI across Indian States together with the bulk of recent FDI being concentrated in the services sector have good electricity infrastructure in common. Higher levels of installed electricity production capacities and lower levels of electricity losses are significantly associated with higher FDI inflows in any given state. Our panel analysis on an original dataset shows that investments in India are affected by a state’s past record of infrastructure including roads, tele density, and electricity. In different models, given the ten years of data, we find statistical significance for a strong positive effect of reliable electricity on the flow of FDI and we conclude that foreign investors’ decisions are influenced by the quality of electricity service provision in each area or region.

 (The above piece is an executive summary of a longer paper by Shashank & Francesca, if interested to read the entire paper click here.)