FDI and growth in India

FDI and growth in India

Beginning of liberalization in Indian economic reforms, FDI played an important role since 1990s. Globalization and privatization are important determinants of FDI inflows in developing countries (De Mello, 1997) such as India. According to World Bank (1999) report that FDI flows to developing countries increased more than six times between 1990 and 1998. The share of FDI in Gross Domestic Investment (GDI) was increased from 0.45% to 2.25% between the periods 1975 to 1997. During the same period the percentage of GDI stands for 20%. If the amount of GDI is not too high in GDP then it shows that FDI flows may have important effect on the national economy. In endogenous model shows a long run growth of FDI inflows only with the government liberalization policies. FDI inflows play a key role in technological development and growth of human capital. This portion highlights the two-way links between FDI and growth. The FDI and growth has mixed effect on countries across the world This two-way relationship between FDI and growth has two dimensions called short run and long run. In short run, FDI may attract by the low labour cost and outward oriented government policy of the host country. The growth of FDI may affect on growth through knowledge 'spillover'. Long run, FDI attracted by the technology transfer and it effects on nation's infrastructure. Cointegration theory has been used to determine the short run and long run relationship between the FDI and growth in India. The advantage of cointegration approach to identify the restrictions of both short and long run dimensions and it allows one of the dimensions to combine the FDI and growth. Additionally, two more variable added to determine the relationship of FDI and growth such as Unit Labour Cost (ULC) and share of Import Duty in the tax revenue (IMPDT). India is a country with lower unit cost labour, so India has an impact of FDI inflows in short run. Meanwhile, IMPDT may helpful to the host country and this may affect the relationship between FDI and growth in the long run. Vector Error Correction model (VECM) has been introduced to clarify the various questions in cointegrating approach. Finally, the results from VECM has suggested that India has positive short run impact on FDI inflows and also identified GDP in India is not caused by FDI.

FDI flows for India

For foreign investment receiving countries market sizes or firm size and cost structure are important determinants. By this market size and cost structure policy regimes of the developing countries may create direct or indirect impact on FDI flows. To study these impacts endogenous is necessary for FDI flows. Therefore, in India it is essential to approach cointegration to observe the relationship between FDI and growth. The GDP indirectly reflects the size of the domestic market and it is eliminated as key variable in model. The variable ULC play a significant role in India and directly effects on India to attract FDI because wage rate in India is comparatively cheaper than other countries. Import Duties in tax revenue (IMPDT) are included as a exogenous variable in cointegration approach. This variable reflects on trade regime of the host country and suggestive of the liberalization in the developing countries. The FDI is expected to take place under the trade regimes between the foreign countries and developing countries. It is assumed that trade liberalization treated as a imperfect in cointegrating approach to identify the relationship between FDI and GDP. Since trade regime plays a key role in model it would help establish a long run relationship between FDI and GDP. Although India started trade liberalization in 1984 later accepted government policies in liberalization during 1991 when the country encounter severe balance of payment crisis.

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