Need help?
Call now 0207 118 0808

GET PRICE NOW

Writer's Profile
Matthew West

Specialised Subjects

Accounting, Economics, Finance

I hold a distinction in Masters in International Banking and Finance from University of Glasgow and also hold a Bachelors degree in Commerce from a premier institute. During these years, apart from academic excellence I also held various posts of responsibilities. I have worked for more than three years in banking and the investment field, covering areas like budgeting, forecasting, planning and analysis, investments and also retail banking operations and marketing. I am currently a part qualified ACCA candidate. My academic pursuits and varied job experiences have enabled me to gain a vast exposure to many areas of the financial world. My projects and dissertation have covered topics mainly from finance (e.g. – valuation techniques, investment performance, portfolio management, foreign exchange, financial analysis and performance evaluation) and economics (e.g. – monetary policy, central banking and financial structure) apart from others.

Has FDI (Foreign Direct Investment) played a role in the Indian growth story?

Introduction
This paper examines the impact that FDI (Foreign Direct Investment) had on the overall economic growth and on the growth of manufacturing and services sectors in India from 1991 to 2007. The existing literature provides conflicting results and predictions regarding growth effects of FDI to host economies, particularly for developing economies. This paper revisits this relationship in an Indian context using the model adopted by Alfaro, L. (2003) to determine if FDI has acted as a catalyst to growth in India at the sector level. India is one of the top destinations for offshore investments. However, FDI share in GDP is quite small, which makes this study quite interesting. The paper conducts a multiple regression test using various growth parameters on SPSS.

Background:
The study of India is interesting due to its imperfect market conditions and relatively less developed and weakly integrated financial sector. FDI in India has been a cause of endless political debates with some in favour of trade openness and global integration while others doubting heavily the relative merits of a liberalised investment regime in all economic sectors. For instance, entry of retail giants like Wal-Mart and the FDI in retail has been under the political scanner for long now. Retail in India is the second largest contributor to GDP (14%) employing 500,000 in the organised sector and 49.5 million in the unorganised sector. The magnitude of expansion of retail gives an obvious impression of this sector being the ‘sunrise sector’ of India (Guruswamy et al. 2005). It is often argued that the existence of multinational enterprises may erode domestic savings and investment. Consequently, many domestic firms shall eventually be driven away as they cannot sustain rising cost pressures and competition amidst a scarcity of resources. The oligopolistic and cash superior foreign firms invest in emerging economies to take advantage of their local resources, logistics, cost differentials and market conditions and the subsequent repatriation of profits shall drain the valuable capital out of the host country. Also it may have negative effects on employment generation.
On the other hand, many policy makers and academics are of the view that FDI nurtures linkages with domestic firms and gives economic growth process a jumpstart. It has positive effects on the host country’s development efforts through supply of capital and technology. It is for this reason that many industrialised and emerging economies like India have adopted a liberal trade and investment regime. Recently, it has been argued that the perceived costs and benefits of foreign investment in the manufacturing and services sectors are similar to a substantial degree and that the distinction between them is getting blurred with time. FDI effectiveness depends largely on country circumstances (Mody, A. 2004).

The earlier studies have produced conflicting results: positive impact (Aitken et al. 1997); negative impact (Gorg and Greenwood 2002); spillover effects through technology and knowledge transfer (Choe, J.I. 2003); conditional impact (Alfaro et al. 2003) and no impact (Lipsey, R.E. 2002)

Data sources and Methodology:
The project includes data on following variables collected from various sources:

  1. Foreign direct investment (UNCTAD WIR 1991-2007; OECD 2001-2005; Reserve Bank of India 1991-2007)
  2. Government spending (Reserve Bank of India 1991-2007)
  3. Inflation (IMF 1991-2007)
  4. Trade openness (World Bank Development Indicators 2005-07)
  5. Institutional quality (International Country Risk Guide 2007)
  6. Private credit (RBI 1991-2007)
  7. Schooling (World Bank Development Indicators 2005-07)
  8. Domestic investment (http://www.indiabudget.nic.in)

Appendix 1 shows descriptive data. Initial GDP is the real GDP per capita at the beginning of the period. FDI/GDP is the total FDI inflows as a percentage of GDP. For different sectors, it is the average FDI as a percentage of GDP. The data for annual FDI in each sector is missing and hence has not been included. Moreover for the purpose of the research only average figures of FDI in each sector is needed. Schooling is the average number of students in secondary education as a percentage of total population for each year. Government spending is the average share of government expenditure on consumption as a percentage of GDP. Inflation figures are calculated form annual inflation levels of CPI. Institutional quality is measured as the average of sub indices of Political Risk as measured by the International Country Risk Guide online database. Private credit represents the value of credits extended by financial intermediaries to the private sector as a percentage of GDP. Domestic investment is the Gross Domestic Capital Formation (GDCF) as a percentage of GDP. Openness is the average of exports and imports together as a percentage of GDP.

Initially, the paper shall study the impact of overall FDI inflows on economic growth of country. The equation for regression purpose is:

GROWTHi = β0+ β1INITIAL GDPi + β2CONTROLSi + β3FDIi + vi             (I)

It is to be noted here that the dependent variable growth is the average real annual per capita growth rate. Controls include the various endogenous variables or growth determinants that shall be included to test the hypothesis and FDI relates to the overall average FDI inflow into the economy as a percentage of GDP. The last unit is the random error coefficient.

The hypothesis is further tested at sector level by testing the impact of FDI in different sectors on growth. The existing literature supports that FDI has been more relevant for manufacturing sector and to some extent the services sector in context of India. The equation used here is:

GROWTHi = β0+ β1INITIAL GDPi + β2CONTROLSi + β3FDIi j + vi        (II)

The equation remains the same as earlier except that ‘j’ corresponds to the manufacturing or services sector.

Results:
The multiple regressions have been carried out on SPSS 15 and the results are shown below.

  • Impact of Total FDI on Growth: Appendix 2 presents the main results obtained. The role of FDI in spurring overall economic growth is insignificant. The share of average FDI is seen to be greater at higher levels of growth which indicates that foreign investors have invested heavily in recent times when India’s growth has been more pronounced and stable. The macroeconomic stability has encouraged higher investments when the fundamentals of government are found to be stronger.
  • Impact of FDI in Manufacturing and Services Sectors on Growth: Equation II is used here to judge if FDI in manufacturing and services has produced positive externalities. Appendices 3 and 4 are used to summarise effects on manufacturing and services, respectively.

The coefficients of determination are significantly high enough for manufacturing and thus imply a stable relationship between FDI and growth in manufacturing after controlling for initial income and growth determinants. The correlation between GDP growth and manufacturing growth is also found to be 0.692; showing a significant contribution of this sector in economic growth. For the services sector, we find very insignificant coefficients in some, while others show quite large values. The impact does appear to be positive but somehow, this sector may have been underinvested in. The correlation of overall GDP growth and services sector growth is 0.594. Also, services are the largest contributor to country’s FDI (more than 60%). While most of the FDI, particularly through the automatic route, have been in the services sector, the role of FDI in stimulating growth in this sector is yet to reach a significant level.

Conclusion:
FDI seems to produce no robust positive impact on overall economic growth. The manufacturing sector shows significant positive results while evidences for the services sector are weak, nevertheless positive. FDI effectiveness depends on country circumstances and India needs to develop domestic capacities to absorb the maximum benefits from foreign capital, technical and knowhow inflows. The role of FDI in promoting exports is believed to be most critical in spurring investment and growth.

References:
Aitken, B.J., Hansen, B. and Harrison, A.E. (1997). Spillovers, Foreign Investment and Export Behaviour. Journal of International Economics (43), pp. 103-132

Alfaro, L. (2003). Foreign Direct Investment and Growth: Does the Sector Matter? Harvard Business School, April 2003

Choe, J.I., (2003). Do FDI and Gross Domestic Investment Promote Economic Growth? Review of Development Economics, 7 (1), pp. 44-57

Gorg, H. and Greenwood, D., (2002). Much Ado about Nothing? Do Domestic Firms Really Benefit from FDI? Research Paper No. 2001/37, Centre for Research on Global and Economic Policy, Nottingham

Guruswamy, M. Sharma, K. Mohanty, J.P. and Korah, T.J. (2005) FDI in India’s Retail Sector: More Bad than Good, Centre for Policy Alternatives, New Delhi, India

Mody, A., (2004) Is FDI Integrating the World Economy? World Economy, 2004

OECD: International Direct Investment Statistics Yearbook, (2001 and 2005)

Reserve Bank of India (1991-2007) http://www.rbi.org.in

UNCTAD (1991-2007) http://www.unctad.org/wir

http://www.unctad.org/fdistatistics

World Bank (1991-2007) http://www.worldbank.org

World Trade Organisation (2004) International Trade Statistics, WTO, Geneva

World Trade Organisation (2005) World Trade Report, WTO, Geneva

APPENDIX

1. Descriptive Statistics

Mean Std. Dev. Min. Max
Per Capita Real GDP Growth (%) 4.57% 1.86% 2.13% 7.75%
Initial GDP (US $) 434.99 78.84 326.61 588.45
Nominal GDP (US $ Billions) 445.65 158.25 245.55 805.73
Real GDP (US $ Billions) 424.81 112.8 273.36 644.11
GDP _ Primary (US $ Billions) 114.08 13.89 91.68 147.13
GDP _ Manufacturing (US $ Billions) 67.16 8.59 56.62 89.52
GDP _ Services (US $ Billions) 243.23 44.39 198.08 360.58
FDI _ Manufacturing (US $ Million) 995.76 775.83 35.01 2629.36
FDI _ Services (US $ Million) 632.09 411.59 42.26 1253.58
FDI Total (In US $ Million) 2382.36 1284.23 165.00 4222.00
FDI _ Manufacturing/GDP (%) 1.42% 0.98% 0.06% 3.24%
FDI _ Services/GDP (%) 0.25% 0.16% 0.02%    0.51%
FDI/GDP (%) 0.52% 0.25% 0.06% 0.89%
Schooling (as % of population) 47.68% 4.53% 34.26% 54.02%
Government Spending/GDP (%) 16.09% 0.87% 15.2% 17.3%
Inflation (%) 6.91% 3.36% 3.77% 13.23%
Institutional Quality 0.55 0.04 0.49 0.59
Private Credit (as % of GDP) 33.21% 5.44% 28% 47.00%
Investment (as % of GDP) 23.89% 2.11% 21.4% 28.4%
Openness 17.92% 2.68% 14.08% 24.21%