foreign direct investment- a catalyst for economic development of india

7/26/2019 Foreign Direct Investment- A Catalyst for Economic Development of India

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Foreign Direct Investment- A catalyst for Economic

Development of India

Binit Kumar, Pillai HOC College of Arts Science and Commerce, Rasayani

Economic growth of a country is determined by the rate of investment .Countries with high

growth rate invest a considerable fraction of their GDP and on contrary the slowly developing

countries are those who fail to invest. It is evident that investment is a vital component of

economic growth.

Economists define the investment as the source of production of goods that will be used to

produce other goods. It is a fact that economists have developed a common opinion about the

constructive effect of investment on economic growth. Yet no consensus is built that either

public investment has a superior impact on economic bustle or private investment. Empirical

evidence from all over the globe proposes that private capital is more fruitful than public

investment.

Foreign Capital flows can be categorised into one of the following category

!. Commercial "oan are in the form of loan from foreign entity to business or government#. $fficial Flow are the assistance from %orld &an'( I)F or other developed countries to

developing Countries and "DC*s+. FPI Foreign Portfolio Investment are investment in instrument which are easily traded(

less permanent( and do not have a controlling sta'e in enterprise. In this category

investment are made via e,uity instruments -stoc's or debt -bonds of foreign enterprise./. FDI Foreign Direct Investment Foreign direct investment -FDI is defined as an

investment involving a long0term relationship and reflecting a lasting interest in and

control by a resident entity in one economy -foreign direct investor or parent enterprise

of an enterprise resident in a different economy -FDI enterprise or affiliate enterprise or

foreign affiliate. 1uch investment involves both the initial transaction between the two

entities and all subse,uent transactions between them and among foreign affiliates.! 2

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FDI means investment by non0resident entity3person resident outside India in the capital of an

Indian company under 1chedule ! of Foreign E4change )anagement -5ransfer or Issue of

1ecurity by a Person 6esident outside India 6egulations( #777.#

FDI is capital flows in the form of investments from a parent firm to a location outside the

parent firm*s country of origin. Foreign Direct Investment includes intercompany debt apart

from e,uity capital and reinvested earnings. FDI is composed of a parent enterprise( which

invest for some amount of control over foreign affiliate( and a foreign affiliate. 5his concept

of control was developed by 8ymer -!9:7 and is crucial to the distinction between portfolio

and direct investment as well as the motivation behind the firm*s investment. + Control is

usually defined as owning !7; or more of the voting shares.

Foreign Direct Investment -FDI is always seen as important driver for economic growth in

the developing economies. FDI wor'ed as important catalyst in economic growth of countries

li'e India. 5he interdependence of economic growth and Foreign Direct Investment -FDI has

long been a sub<ect of great interest for modern economist and policy ma'ers. In current

volatile economic environment stable inflows of global capital emerges as an effective

channel to faster growth in developing countries.

5he advantage from FDI inflows are immense as it contributes to economic growth and

development through an increase in productivity of host country by providing new

investment( technology transfer( employment generation( 8uman resource development

managerial s'ills development. FDI helps in improvement of e4ports and international trade.

5he impact of FDI on economic growth depends on capacity of the host country to use FDI

efficiently. 1imilarly( trade liberali=ation may facilitate economic growth through efficiency

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in production by utili=ing the abundant factors of production more effectively and absorbing

better technologies from advanced countries. It may also harm the economic growth process

through various forms of macroeconomic instability such as deterioration in terms of trade

and balance of payments problem. 5herefore( it is a challenge for developing countries li'e

India to find out the appropriate way to manage FDI and trade liberali=ation for economic

growth.

5his paper is a modest attempt to e4amine the empirical relationship between FDI and

economic growth in India from !99! to #7!/. 5he main focus of this study is to find whether

the economic growth of India in any way related to surge in inflows of foreign direct

investment into India or not. 1ince !997 is the year from which the inflows of FDI started

entering on a significant scale on account of adoption of >ew Economic 6eforms and Policy

of "iberali=ation in India.

FDI Policy /

? foreign company planning to set up business operations in India may

!. Incorporate a company under the Companies ?ct( !9@:( as a Aoint Benture or a

%holly $wned 1ubsidiary.

#. 1et up a "iaison $ffice 3 6epresentative $ffice or a Pro<ect $ffice or a &ranch $ffice

of the foreign company

?n Indian company may receive Foreign Direct Investment under the two routes as given

under

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i. ?utomatic 6oute FDI is allowed under the automatic route without prior approval

either of the Government or the 6eserve &an' of India

ii. Government 6oute FDI in activities not covered under the automatic route re,uires

prior approval of the Government which are considered by the Foreign Investment

Promotion &oard -FIP&( Department of Economic ?ffairs( )inistry of Finance.

Foreign investment is rec'oned as FDI only if the investment is made in e,uity shares(

fully and mandatorily convertible preference shares( fully and mandatorily convertible

debentures( Partly paid e,uity shares and warrants issued by an Indian company w.e.f. Auly (

#7!/

?ny foreign investment into an instrument issued by an Indian company which

• gives an option to the investor to convert or not to convert it into e,uity or

• does not involve upfront pricing of the instrument as a date would be rec'oned as

EC& and would have to comply with the EC& guidelines.

THEORETICAL FOUNDATION

Production is function factor input and resources. )a<or factor inputs are land( labour capital

and enterprise. It is evident that factor abundance and intensity varies from country to

country. In India some of the factors are in abundance and some are scarce. Capital and

enterprise falls in category of scarce resources. FDI is important source of these two

resources. Capital from foreign countries flows along with technology( entrepreneur and

managerial s'ills.

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8owever( the effect of FDI on domestic investment is an issue of concern because there is a

possibility of displacement of domestic capital due to competition from foreign investors with

their superior technologies and s'ills. 5hus( the ultimate impact of FDI on economic growth

depends on the degree of capacity of the host country to use FDI as efficiently as possible.

Foreign Direct Investment -FDI is often seen as an important catalyst for economic growth

in developing countries. Growth economists have argued that countries having high growth

rates are pursuing outward0oriented growth strategies. ? number of studies have e4amined

the relationship between inward foreign direct investment -FDI and economic growth in the

developing countries. ? generally accepted conclusion is that FDI has played a significant

role in promoting economic growth in host countries because FDI represents the

transmission to the host country of a pac'age of capital( managerial s'ills( and technical

s'ills -Dattaray #77+.

TRENDS OF FDI INFLOWS INTO INDIA

5he inflows of FDI into India were low during !97 to !97. During the period from !97 to

!997( the inflows of FDI into India had grown considerably. Post !99# when liberalisation

has started inflows of FDI into India had grown si=ably during the period from #777 to

#77.5he value of FDI inflows has rose from +.@ billion of 1H in #777 and touched the

highest level of /+./ billion of 1H in #77. &ut due to global meltdown FDI inflow declined

in subse,uent years and reached to #/ billion of 1H in #7!#. In last two year with

improvement in economic condition FDI inflows reached to +/./ billion of 1H in #7!/.

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1ource world ban'

1ource world ban'

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In billion US $






Year

GDP growth (annual

!

FDI growth (annual

!

!9: !.:: 0#@.+

!9 .#@ +:.9#

!9 @.! 0!@7.!

!99 0@.#/ !:./9

!97 :./ :#.9

!9! :.7! !:.!#

!9# +./ 0#!.@

!9+ .#9 09#.!

!9/ +.# #/!.!+!9@ @.#@ /@!./7

!9: /. !7.9

!9 +.9 7.+/

!9 9.:+ [email protected]#

!99 @.9@ !:.#

!997 @.@+ 0:.!!

!99! !.7: 0:.9+

!99# @./ #:.7!

!99+ /.@ 99.7/

!99/ :.:: :./

!99@ .@ !#7.#@

!99: .@@ !+.!

!99 /.7@ /./@

!99 :.! 0#:.+@

!999 .@ 0!.:9

#777 +./ :@.#

#77! /.# @#.:

#77# +.7 #.#

#77+ .: 0#+.!#77/ .9# ++.@!

#77@ 9.# #@.9:

#77: 9.#: !@.@+

#77 9.7 #@.9:

#77 +.9 #.7:

#779 ./ 0!.7+

#7!7 !7.#: 0#+.77

#7!! :.:/ ++.##

#7!# @.7 0+/.#:

#7!+ :.97 !.++#7!/ ./# ##.#+

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Sour"e # Worl$ %an&

GDP growth rate# Percentage change of real GDP compared to previous year. 6eal GDP is

ad<usted for inflation.

1ource world ban'

RE'IEW OF RELATED LITERATURE

5he relationship between FDI and economic growth has been vigorously investigated by

various economic researchers for different sample time periods and provide conflicting

evidences and findings on this issue. 5his conflicting nature of evidence is attracting more

and researchers to study the relationship between these two economic variables.

)atthew 5yler "und in his research F$6EIG> DI6EC5 I>BE15)E>5 C?5?"Y15 $F

EC$>$)IC G6$%58 observed FDI as a composite bundle of capital stoc' and

technology( and can augment the e4isting stoc' of 'nowledge in the host economy through

labour training( s'ill ac,uisition and diffusion( and the introduction of new managerial

practices and organi=ational arrangements. >ew endogenous growth models allow FDI to

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impact economic growth in the long run through 'nowledge transfers from the )>E to the

host country. 5he findings here suggest that the impact of FDI on economic growth is not as

obvious as previously thought. FDI may potentially impact economic growth positively but is

dependent on many factors such as host country characteristics( FDI policy( and the type of

FDI.

Dr. 1.?. 1aiyed -#7!# in his wor' Effect of Foreign Direct Investment on Economic

Growth in India ?n Empirical Investigation e4amined the causal relationship between

Foreign Direct Investment and economic growth in India. 8e observed strong positive

correlation between Foreign Direct Investment and growth of Gross Domestic Product.

6egressions analysis revealed that Foreign Direct Investment e4pansion has influenced

output variablesJ increase in Foreign Direct Investment causes annual output to increase. 8is

empirical wor' indicates that whatever may be the cause of rise in stoc' of Foreign Direct

Investment in India( but it definitely leads to rise in the output growth.

Foreign direct investments* interaction with human capital has received considerable

attention. "i and "iu -#77@ in a panel data analysis for / countries over the period !97‐99

found that FDI affects growth directly and also indirectly through its interaction with human

capital. 5hey also found a negative coefficient for FDI when it is interacted with the

technology gap between the source and host economies. 5his suggests that greater

technological differences between the source and host country hinders the host countries

ability to benefit from FDI. In a panel data framewor' for a sample of ! "atin ?merican

countries for the period !97‐99( &engoa et al. -#77+ found that FDI affects growth

positively. In order for a positive effect from FDI to be achieved( the country must have an

ade,uate level of human capital( economic stability( and liberali=ed capital mar'ets.

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5hough this is not an e4haustive survey of the literature that has gone into this area( I feel that

it does provide enough analytical framewor's for enabling us to underta'e the present study.

O%ECTI'ES OF THE PAPER)

5o investigate empirically whether the economic growth -GDP is effected by Foreign Direct

Investment -FDI or not( by using annual data of Indian Economy over the post reforms

period !99709! to #7!+0!/.

HYPOTHESES OF THE STUDY

Foreign Direct Investment is one of the important causes of accelerated growth in Gross

Domestic Product of the economy and subse,uently increased economic growth in India.

DATA SOURCE AND *ETHODOLOGY

In this study( empirical analysis is underta'en to establish relationship between Foreign

Direct Investment -FDI and Economic Growth -GDP and their causality using annual

secondary data for Indian Economy over the period !99709! to #7!+0!/ by applying

Computer software pac'age( namely( )1 E4cel.

?ll these data are collected from the %orld Growth Indicators -%DIJ data published on

website http33data.worldban'.org3country3india by the %orld &an'( %orld Investment

6eport -%I6 published by the >C5?D( Fact 1heet on Foreign Direct Investment -FDI by

Department of Industrial Policy and Promotion -DIPP and 8andboo' of 1tatistics on the

Indian Economy by 6&I( Economic 1urvey -Government of India.

FDI + GDP Relat,on-h,.#

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8ere( to establish a relationship between Foreign Direct Investment and economic growth

-GDP I applied Pearson*s co0relation. In this study I also applied the ?utoregressive model

to measure Foreign Direct Investment Koutput relationships( as specified in two variable

models to establish causal relationship between FDI and GDP.

Two 'ar,a/le Regre--,on *o$el

6egression estimates covering period from !99709! to #7!+0!/ is presented with both

dependent and independent variables below.

De.en$ent 'ar,a/le# Gro-- Do0e-t," Pro$u"t (GDP!1 In$e.en$ent 'ar,a/le# Fore,gn

D,re"t In2e-t0ent (FDI!

Co+relat,on 2alue o3 r45)677 an$ r8 45)656 -how- a -trong .o-,t,2e "o+relat,on /etween

the two 2ar,a/le- GDP an$ FDI

L,ner Regre--,on 0o$el 3or GDP 4 a 9 /: FDI

%here GDP stands for Gross Domestic Product year0wise and

FDI stands for the year0wise total Foreign Direct Investment of India

Regre--,on re-ult-# (For ;775+7; to 85;<+85;= $ata!

GDP4<>6)589<?)?@:FDI

S,gn,3,"ant at @ le2el o3 -,gn,3,"an"e

5he above regression result supports the fact that the relationship between Foreign Direct

Investment -FDI and Gross Domestic Product year0wise is significant and positive

Guarat Co+relat,on 2alue o3 r45)?;7 .o-,t,2e "o+relat,on /etween the two 2ar,a/le-

GDP an$ FDI

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Barnata&a Co+relat,on 2alue o3 r45)<?7 wea& .o-,t,2e "o+relat,on /etween the two

2ar,a/le- GDP an$ FDI

*ahara-htra Co+relat,on 2alue o3 r45)@>> .o-,t,2e "o+relat,on /etween the two 2ar,a/le-

GDP an$ FDI

CONCLUSION POLICY RECO**ENDATIONS

5he main ob<ective of this study is to find out dependency of Economic Growth on FDI and

relationship between Foreign Direct Investment and economic growth in India. From the co0

relation and linear regression analysis of data it is evident that there is a strong positive

correlation between Foreign Direct Investment and growth of Gross Domestic Product.

6egressions analysis revealed that e4pansion of Foreign Direct Investment has a positive

impact on GDP( changes in Foreign Direct Investment causes annual output to increase. )y

study reveals the e4istence of causality between Foreign Direct Investment and GDP. )y

results indicate that rise in inflow of Foreign Direct Investment in India( whatever may be the

causeJ will definitely leads to rise in the GDP.

India need Foreign Direct Investment -FDI as a strategic component of investment for its

sustained economic development and growth through generation of employment( e4pansion

of capacities of e4isting manufacturing industries( pro<ect in the field of healthcare(

education( research and development -6 L D etc.

Government must design the policy to attract FDI in such a way that it can be utili=ed as

means of increasing domestic production( savings and e4ports through the e,uitable

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distribution among states by providing much freedom to states( so that they can attract FDI

inflows at their own level.

In India policy ma'ers are loo'ing at FDI as the primary source of funds( but they must be

consider that FDI is not the only solution of rapid growth and development. India needs to

put in place a comprehensive developmental strategy which must include being open to trade

both internal and e4ternal and FDI.

! definition as per >C5?D -nited >ations Conference on 5rade and Development# as per Department of Industrial Policy and Promotion )inistry of Commerce and IndustryGovernment of India Consolidated FDI Policy -Effective from ?pril !( #7!/+ 1ee Cohen et al.-!99 for a collection of 8ymer*s essays./ https33www.rbi.org.in31cripts3F?MBiew.asp4IdN#:

6eference

!. Effect of Foreign Direct Investment on Economic Growth in India ?n EmpiricalInvestigation by Dr. 1.?. 1aiyed( P?6IPEO 0 I>DI?> A$6>?" $F6E1E?6C8( Bolume ! Issue !! >ovember #7!#( I11> 0 ##@70!99!

#. Barious F?C5 18EE5 $> F$6EIG> DI6EC5 I>BE15)E>5 -FDI byDIPP(G$I.

+. 8?>D&$$Q $F 15?5I15IC1 $> 58E I>DI?> EC$>$)Y-http33dbie.rbi.org.in by 6E1E6BE &?>Q $F I>DI? #7!+0!/

/. Consolidated FDI Policy -Effective from ?pril !( #7!/ by Department of Industrial Policy and Promotion ( )inistry of Commerce and Industry (Government of India

@. Impact of Foreign Direct Investment on Indian economy by )ahanta Deva<it Research Journal of Management Sciences ,I11> #+!9K!!!( Bol. !-#( #90+!(1eptember -#7!#

:. F$6EIG> DI6EC5 I>BE15)E>5 C?5?"Y15 $F EC$>$)IC G6$%58&y )atthew 5yler "und

. Impact of Foreign Direct Investment Inflows on the Growth of Indian EconomyDeepa' Qumar L ?nupam( International Aournal of 6esearch -IA6( Bolume0!(Issue0@( Aune #7!/

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