The EU–India deal is not enough. India needs investment – now

The war in Iran, with the closure of the Strait of Hormuz, has just handed India an uncomfortable reminder of its economic vulnerabilities.

India’s heavy dependence on crude oil as well as refined products has further weakened the Indian rupee, which has already suffered from capital outflows since the national elections in June 2024. Surging energy import costs are driving up India’s current account deficit and forcing the Reserve Bank of India to try to mitigate the plummeting rupee as investors flee under the pressure. The only durable answer to this vulnerability is for India to produce more of what it needs, which implies strengthening its industrial and manufacturing base.

To do so, India needs to finally do what it has for years found so difficult – namely, attract more foreign direct investment, particularly in manufacturing. India’s rapid economic deterioration comes right after the EU and India reached a deal for a Free Trade Agreement (FTA) in late January this year. Nearly two decades in the making, the EU-India FTA has liberalised tariffs on a large number of products, creating opportunities for the automotive, pharmaceutical, and digital sectors.

For Indian textile exporters and European carmakers, it delivers real economic gains. But for India’s deeper economic challenges – a fragile current account suffering from a higher oil import bill, and more generally the need to manufacture more of the goods that India needs – this FTA alone cannot do the trick.

China’s limited manufacturing capacity (with only 2.8% of global manufacturing compared to close to 30% for China) is also behind India’s most important economic challenge, namely that of creating high-quality jobs for its growing labour force. In fact, eight to ten million young Indians enter the labour market every single year while formal manufacturing employment barely increases. Over half the workforce remains in agriculture, the sector with the lowest productivity.

India’s thirst for manufacturing FDI should be obvious since it has hardly attracted any. Vietnam, a country of 100 million people, has FDI equivalent to 4.2% of its GDP. India is below 1%. This reflects structural barriers – infrastructure gaps, rigid labour markets, import tariffs that make export-oriented production uneconomical, and, most damagingly, the near-total collapse of India’s bilateral investment treaty network after New Delhi unilaterally terminated over 70 treaties between 2016 and 2018.

Research shows that these terminations reduced FDI inflows by more than 30%. For a European manufacturer contemplating a greenfield factory in India with a 20-year investment horizon, the absence of enforceable investor protection is not a bureaucratic detail – it is a dealbreaker.

Europe has a direct stake in fixing this. Despite its modest headline numbers, the EU is already India’s largest genuine foreign investor once the round-tripping through offshore financial centres is stripped out. This might be because India is perceived as an alternative as European companies push de-risking from China.

But there are also objective reasons related to India’s rapid growth. The case for redirecting European manufacturing capital toward India – a large, democratic, English-speaking country with a growing middle class and a young workforce – has never been stronger. European companies do not only need new markets in which to sell. They need new places in which to produce at scale, building the integrated supply chains and economies of scale that sustain their global competitiveness.

A painting, welcoming trade deal between India and European Union outside the art school in Mumbai. Photo by Ashish Vaishnav/SOPA Images/LightRocket via Getty Images

The FTA contains an extraordinary omission: it has no commitments on investment market access in the manufacturing sector. Every other recent EU trade deal — with Singapore, Vietnam, Indonesia — includes national treatment and market access commitments for manufacturing investment. The EU–India FTA kicks this to a “rendezvous clause”, promising negotiations within two years of entry into force.

This is a polite way of saying: “we ran out of time and political capital, and we will try again later.” The parallel Investment Protection Agreement, which would provide European investors with enforceable protection against expropriation and discriminatory treatment, remains unfinished.

Both sides need to treat these negotiations as urgent – not as a footnote to the FTA, but as its most important sequel. The agenda is clear: India should commit to binding its already relatively open manufacturing investment regime, giving European companies the legal certainty they need to plan long-term. An investment protection agreement should be concluded that establishes meaningful standards – fair treatment, protection against expropriation, free transfer of returns – with a credible dispute settlement mechanism.

India has announced a new model investment treaty; this is the moment to finalise and deploy it in a deal that matters. Joining the WTO’s Investment Facilitation for Development Agreement, which 127 countries have already signed and which focuses on transparency and administrative streamlining, would send a powerful additional signal that India is serious about attracting FDI, not just in words but in the legal architecture that investors actually rely on.

None of this is technically difficult. India’s manufacturing sector is already largely open to foreign equity. The substantive barriers are institutional and legal, not sectoral. The EU has shown flexibility in its recent investment agreement with Indonesia, using state-to-state dispute settlement as an interim step toward a fuller investor protection mechanism.

A similar pragmatic approach could work with India. The political will exists on both sides – the FTA proved that. What is needed now is the sustained negotiating energy to complete the work. Beyond investor protection, the EU and India could also complement it with a clean trade and investment partnership to help mobilise private investment in the decarbonisation of the Indian economy.

The Middle East crisis is a reminder that India’s economic vulnerabilities are real and immediate. A depreciating currency, a fragile current account, and a jobs market that cannot keep pace with demographic pressure are not abstractions. Manufacturing FDI is the most powerful instrument available to address all three at once: it earns foreign exchange, it creates formal jobs, and it builds the industrial resilience that reduces dependence on imported energy.

The EU–India FTA was a necessary first step. The investment deal is the one that actually transforms the relationship. It is time to stop treating it as an afterthought and start treating it as the priority it is.

The ideas behind this paper stem from a forthcoming Bruegel working paper co-authored with Rajeswari Sengupta “Beyond Tariffs: Why the EU–India Trade Deal Must Prioritise Manufacturing FDI”.