Data Met Lazim Olan Sene

International Research Journal of Finance and Economics
ISSN 1450-2887 Issue 42 (2010)

EuroJournals Publishing, Inc. 2010
http://www.eurojournals.com/finance.htm

A Causal Relationship between Trade, Foreign Direct
Investment and Economic Growth for India

G.Jayachandran
Lecturer in School of Economics, Madurai Kamaraj University, Madurai -625 021, Tamil Nadu, India
E-mail: jeyachandrangurusamy@yahoo.com

A. Seilan
Lecturer in School of Economics, Madurai Kamaraj University, Madurai -625 021, Tamil Nadu, India
E-mail: seilan_a@yahoo.com

Abstract

This study investigates the relationship between Trade, Foreign Direct Investment
(FDI) and economic growth for India over the period 1970-2007. The literature on foreign
direct investment (FDI) Trade and economic growth generally points to a positive Trade
and FDI-Growth relationship. However, very few studies offer direct tests of causality the
three variables. In theory, economic growth may induce FDI inflow, Trade and FDI may
also stimulate economic growth. This paper adds to the literature by analyzing the
existence and nature of these causal relationships. The present analysis focuses on India,
where growth of FDI has been the most pronounced. The Cointegration analysis suggested
that there is a long-run equilibrium relationship. The results of Granger causality test
showed that there is a causal relationship between the examined variables. Economic
growth, trade and FDI appear to be mutually reinforcing under the open-door policy.

Keywords: Foreign Direct Investment, Exports, Imports, Stationarity, Cointegration,
Causalty.

1. Introduction
In the neoclassical growth model, technological progress and labour growth are exogenous; FDI
inflows merely increase the investment rate, leading to a transitional increase in per capita income
growth, but have no long run growth effect. In the new growth theory of the 1980s endogenous
technological progress and FDI has been considered to have permanent growth effect in the host
country through technology transfer and spillover.
In an open economy, technology and trade, especially through exports and imports and thus
promote economic growth (Grassman and Gelpman, 1997, Chapter 9; Frankel and Romer, 1999;
Frankel, Romer, Cyrus, 1996). However, growth also has effects on trade (Rodriguez and Rodrik,
2000). The observations on the FDI growth nexus and Trade growth nexus lead us to examine the
third side of a triangular relations; FDI Trade nexus (Frank S.T. Hsiao, and Mei chu. Hsiao, 2006).
The role of trade policy on economic growth has been the focus of considerable academic
effort. Openness, namely, the sum of exports and imports to Gross Domestic Product (GDP), has been
considered one of the main determinants of economic growth. Export expansion can increase
productivity, offering greater economies of scale. Exports are likely to alleviate foreign exchange
constraints and can thereby provide greater access to international markets (Melina Dritsaki, Caido
International Research Journal of Finance and Economics - Issue 42 (2010) 75
Dritsaki and Antonios Adamopoulos, 2004). Many early studies of the links between exports and
growth confirm a statistical relationship between export growth and out put growth (Michaely, 1977;
Krueger, 1978; Balassa, 1978; and Fedder, 1982).
Similarly, the empirical evidence on the causal relationships between FDI investment and trade
is equally contradictory, with results ranging from unidirectional causality, bidirectional causality, or
even no causality between FDI and trade (Mayang Pramadhani, Rakesh Bissoondeeal and Nget
Driffield, 2007), Pacheco Lopez (2005) finds a two way relationship between FDI and exports and
FDI and imports in Mexico using a Granger causality test. Anther study by Liu et al (2001) concludes
that there were inter linkages between FDI, Exports and imports in china. They suggest that a growth
of imports in china. They suggest that a growth of imports results in a growth of FDI Inflows. In turn
the growth of FDI causes the growth of exports.
Nevertheless, the results obtained by empirical studies, which recently have applied causality
test to examine the nature of a causal relationship between exports and economic growths are also
mixed. Although some studies have found a positive association, others resulted in reverse conclusions.
It is not clear in the literature to what degree is the positive relation between trade and growth due to
the fact that trade is simulative of growth and to what degree it reflects the fact that growth leads to
trade. The rate of economic growth differs from country to country, technological advance increases
slowly or rapidly relatively to the economic structure of each country, while when the monetary and
fiscal policy are not taking account of, they have a negative effect on economic growth (Melina
Dritsaki, Chaido Dritsaki and Antonios Adamopoulous, 2004).
It is well-known that, economic miracle took place in Asia (World Bank 1993), starting from
Japan in the 1960s to early 1970s, followed by four Asian NIEs, Taiwan, Korea, Singapore and Hong
Kong, in the 1970s and 1980s. In the latter half of the 1980s, while the Asian NIEs have continued to
grow, the ASEAN-4, Indonesia, Malaysia, Philippines, Thailand, along with China, started rapid
growth, and the growth fever spread to Vietnam and India in this new millennium. The rapid clustered
sequential growth of Asia is unique in the history of economic development not shared by the other
regions or areas of the world (World Bank 1993; UNCTAD 1995; Fukasaku 2006), and is dubbed as
the flying-geese model of development (Kojima 2000; Ozawa 2003). The collapse of the Thai baht
in mid-1997 triggered Asian financial crisis, and the economies of most of the Asian countries suffered
(ADO 1999), especially Korea, Malaysia, Philippines, and Thailand. Nevertheless, within a few years,
all Asian economies have successfully resumed their rapid growth since then.
Compared with real GDP and real export activities, real FDI in each economy fluctuates
considerably. China and Hong Kong, and possibly in Singapore are exception. Thus, one may doubt
the importance of FDI on an economy. Furthermore, except China and, to a lesser degree, Hong Kong,
real FDI tends to decrease after the 1997 Asian financial crisis, prompting one to wonder whether
inward FDI in these other countries were redirected to China, and thus reducing the influence of FDI
on GDP. It should be pointed out, however, that, while the size of FDI may be very small compared
with the level of GDP and even exports, it has been observed that FDI generally goes to the key
industries like electric and electronic and high-tech manufacturing sectors of these economies, and
plays a crucial role in promoting technology transfer and exports in these sectors. Thus, FDI may have
a strong influence on the growth of GDP in a country.
The growth of world foreign direct investment (FDI) in recent years has been remarkable. The
US dollar value of world FDI inflows reached US$1.3 trillion in 2000 from just over US$200 billion in
1993. In 1980, FDI stock represented the equivalent of only 5 per cent of world GDP; this percentage
had almost tripled to 14 per cent by the end of the 1990s. The share of developing countries in FDI
inflows has been raised from 17.1 per cent in 198890 to 21.4 per cent in 19982000 (UNCTAD
2000). Over the last decade FDI flows have grown at least twice as fast as trade (Gorg and Greenaway
2004). Empirical evidence that FDI has made a positive contribution to the economic growth of
developing countries has accumulated fast. Some recent examples are Marwah and Klein (1998) for
India; Li, Liu and Rebelo (1998), Sun (1998) and Liu (2002) for China; Ramirez (2000) for Mexico;
Lim and McAleer (2002) for Singapore; Marwah and Tavakoli (2004) for Indonesia, Malaysia, the
76 International Research Journal of Finance and Economics - Issue 42 (2010)
Philippines and Thailand. Borensztein, Gregorio and Lee (1998) and Makki and Somwaru (2004) are
also among the cross-country studies which find positive impacts of FDI on economic growth in
developing countries. In general, most governments believe inward FDI can contribute to the growth of
the host countrys economy. Not surprisingly, since the 1980s, attracting FDI has been one of the most
important policy goals of developing countries.
The traditional Heckscher Ohlin Samuelson frame work, suggests that international trade
and FDI are substitutes assuming labor and capital can move freely between countries and no
transportation costs apply. The implication is that international trade involves an indirect exchange of
production factors between countries (Liu et al, 2001). The link between technology and economic
growth has been highlighted by an OECD study of both OECD and developing countries, which have
found a significant effect on economic growth from the innovation and diffusion of technology.
Foreign Direct Investments can contribute to economic growth because they tend to be more
productive than the investments of local firms. Foreign Direct Investments have led to significant
positive spillover effects on the labour productivity of domestic firms.
Against this background, this paper investigates the Causal relationship between Trade, Foreign
Direct Investment and Economic Growth for India. FDI in India increased to 5472 millions of US
Dollars in 2001 from 2315 millions of US Dollars in 2000. It increased further to 5627 millions of US
Dollars in 2002. After a decline in 2003, it increased to 6598 millions of US Dollars in 2005. The
average value of FDI in this period works out to 5551.2 millions of US Dollars. In this period FDI
increased by 1.2 times in India. (IFS 2006-07).

2. Foreign Trade Indicators of India during 1970 2007
2.1. Exports
The data on Exports of India are given in Table 1. The Exports of India grew from 2 billions of US
Dollars in 1970 and touched 7.8 billions of US Dollars in 1979. In this decade (1970-1979) Exports
index number had grown by more than three times in 1979. In this decade, the highest annual growth
rate was 34.6 per cent in 1974. During the decade 1970 1979, the average value of Exports by India
and the growth rate comes about 4.4 billions of US Dollars is 31.69 per year, respectively.
In the next decade, the Exports of India have grown considerably. The value of Exports touched
the highest level of 15.8 billions of US Dollars in 1989 from 8.3 billions of US Dollars in 1981. The
average value of Exports and annual growth rate in this decade work out to 10.4 billions of US Dollars
and 9.43 per cent per year, respectively.
During the decade 1990 1999, since 1991, the Exports of India had grown substantially. The
value of Exports grew from 17.7 billions of US Dollars in 1991 to 35.7 billions of US Dollars in 1999.
The average value of Exports and the annual growth rate in this decade work out to 27 billions of US
Dollars and 10.94 per cent per year, respectively.
During the time period 2000 -2007, the Exports of India had grown sizeably. The value of
Exports grew from 42.4 billions of US Dollars in 2000 to 145.4 billions of US Dollars in 2007. The
average value of Exports and annual growth rate in this decade work out to 79.7 billions of US Dollars
and 34.74 per cent per year, respectively.

2.2. Imports
The data on Imports of India are given in Table 1. During the decade, 1970 1979, the Imports of
India had grown sizeably. The value of Imports grew from 2 billions of US Dollars in 1970 to 9.8
billions of US Dollars in 1979 the average value of Imports and annual growth rate work out to 5.2
billions of US Dollars and 40.3 per cent, per year respectively.
In the next decade, since 1984, the Imports of India had grown gradually. The value of Imports
had increased from 15.3 billions of US Dollars in 1984 to 20.5 billions of US Dollars in 1989. The
average value of Imports and annual growth rate work out to 16.2 billions of US Dollars and 4.3 per
cent, per year, respectively.
During the decade 1990 1999, since 1991, the Imports of India had grown substantially. The
value of Imports grew from 20.4 billions of US Dollars in 1991 to 47 billions of US Dollars in 1999.
The average value of Imports and annual growth rate work out to 32.1 billions of US Dollars and 11.03
per cent, per year, respectively.
During the time period 2000-2007, since 2002, the Imports of India had grown considerably.
The value of Imports had increased from 56.5 billions of US Dollars to 21.6 billions of US Dollars in
2007. The average value of Imports and annual growth rate work out to 108 billions of US Dollars and
45.5 per cent, per year, respectively.

2.3. Foreign Trade Deficit
The data on foreign trade deficit in India are given in Table 1. In the year 1972 the Balance of
payments shows a positive trend. The trade balance displayed deficits which was the lowest in 1970
and highest in 1975 during the decade 1970 -1979, with 98 millions of US Dollars and 2.1 billions of
US Dollars respectively. During the decade the rate of Export / Import coverage ratio was the highest
in 1972 and the lowest in 1975, with 110.1 per cent and 68.3 per cent respectively averaging 88.32 per
cent.
In the next decade(1980-1989), the trade balance displayed deficits which was the lowest in
1989 and highest in 1981, with 4.7 billions of US Dollars and 7.1 billions of US Dollars respectively.
During the decade the rate of Export / Import coverage ratio was the highest in 1989 and lowest in
1981, which was 77.24 per cent and 53.8 per cent respectively, averaging 63.44 per cent.
During the decade 1990 1999, the trade balance displayed deficit which was the lowest in
1993 and highest in 1999, with 1.2 billions of US Dollars and 11.3 billions of US Dollars respectively.
During the decade the rate of Export / Import coverage ratio was the highest in 1993 and lowest in
1999, which was 94.7 per cent and 75.9 per cent respectively, averaging 84.77 per cent.
During the period from 2000 2007, the trade balance displayed deficit which was the lowest
in 2002 and highest in 2007, with 6.1 billions of US Dollars and 70 billions of US Dollars respectively.
During the period the rate of Export / Import coverage ratio was the highest in 2002 and lowest in
2007, which was 89.13 per cent and 67.49 per cent respectively, averaging to the level of 77.71 per
cent.

2.4. FDI Inflows into India
The data on FDI inflows into India are given in Table 1. During the period from 1970 to 1979, the
value was very low and it ranges from 18 millions of US Dollars to 85 millions of US Dollars. The
average value of FDI inflows and annual growth rate in this decade works out to 45 millions of US
Dollars and 0.99 per cent per year respectively.
During the period from 1980 to 1989, the FDI inflows into India had grown considerably. The
value of FDI Inflows has increased from 6 millions of US Dollars in 1983 to 252 millions of US
Dollars in 1989. The average value of FDI inflows and annual growth rate in this decade works out to
104.7 millions of US Dollars and 24.33 per cent per year respectively.
In the next decade, the value of FDI inflows increased to the highest level of 3.6 billions of US
Dollars in 1997 from 75 millions of US Dollars in 1991 and then it started showing a declining trend, it
has come down to 2.1 billions of US Dollars in 1999. The average value of FDI inflows and annual
growth rate in this decade works out to 1.5 billions of US Dollars and 90.53 per cent per year
respectively.
During the period from 2000 to 2007, the FDI inflows into India had grown sizeably. The value
of FDI inflows has rose from 3.9 billions of US Dollars in 2000 and touched the highest level of 23
billions of US Dollars in 2007. The average value of FDI inflows and annual growth in this period
works out to 9.4 billions of US Dollars and 77.17 per cent per year respectively.

3. Pervious Studies
This section is devoted to present a brief review of the earlier works on the relationship between FDI
inflows, Trade and Economic Growth. The available research works on FDI, Trade and Economic
Growth are grouped under the following three categories:
I. Studies analyzing the relationship between FDI inflows, Trade and Economic Growth.
II. Studies analyzing the relationship between FDI inflows and Economic Growth.
III. Studies analyzing the relationship between FDI inflows and Trade.

3.1. Studies Analyzing the Relationship between FDI Inflows, Trade and Economic Growth
Mayang Pramadhani, Rakesh Bissondeeal and Nigel Driffield (2007) have examined the causal
relationships between inward direct investment, growth and trade in Indonesia for the period 1990
2004. They seek to establish whether there were strong, weak positive or negative associations between
the presences of multinational enterprises and Indonesian exports and imports determent the causal
links between the variables.
The Foreign Direct Investment (FDI) has contributed significantly to Malaysias electronics
exports as well as the growth and development of the electronics industry (Koi Nyen Wong and Tuck
cheong Tang (2007).
Frank S.T. Hsiao and Mei chu W. Hsiao (2006) have examined the Granger causality
relations between GDP, Exports and FDI among East and Southeast Asia. In this Paper, the authors
estimated the VAR and VECM of the three variables to find various Granger Causal relations for each
of the eight Economies and they used the fixed effects and random effects approaches to estimate the
panel data VAR equations for Granger Causality tests.
Zhang (2005) examines the role of FDI on Chinese export performance. The investigation is
not only the estimates of full sample of industries. The result indicates that FDI has a superior
influence on export performance in China at the industrial level.
Pacheco Lopez (2005) demonstrates the causal relationship between inward FDI and Export
performance on Mexico by using the Granger causality test. The result indicates that there is a bi
directional causality between inward FDI and export performance.
Melina Dritsaki, Chaido Dritsaki and Antonios Adamopoulos (2004), investigates the
relationship between Trade, Foreign Direct Investment (FDI) and economic growth for Greece over the
period 1960-2002. The cointegration analysis suggested that there is a long run equilibrium
relationship among the above variables. The results of Granger causality test showed that there is a
causal relationship between the Economic growth, trade and FDI.
Metwally (2004) tests the relationship between FDI, exports and economic growth in three
European Union (EU) countries, Viz., Egypt, Jordan and Omen, during the period from 1981 to 2000
by using a simultaneous equation model. The result suggests that the export of goods and services is
strongly influenced by the inward FDI in these three countries.
Baliamoune Lutz (2004) examines the causal relationship between FDI, Exports and
economic growth in Morocco from 1973 to 1999 by using the Granger causality test. The result shows
that there is a two way causal relationship between FDI and exports at a national level.
Alici and Ucal (2003) investigate the causal links among inward FDI, exports and economic
growth in Turkish economy during the period of 1987 to 2002 on a quarter bases. The linkage of FDI
led export growth is not found in Turkey.
Alireza Karbasi, Ebrahim Mohamadi and Samane Ghofrani (2002) have analysed the role of
FDI and trade in promoting economic growth across selected developing countries and the interaction
among FDI, Trade and Economic growth. The authors examined data from forty two developing
countries over the last three decades. The study results suggest that FDI, Trade, human capital and
domestic investment are important sources of economic growth for developing countries and FDI
stimulates domestic investment.
Liu et al (2002) investigate the causal relationship between inward FDI, trade and economic
growth in China at the aggregate level from 1981 to 1997 on a quarter basis. A two way causal
relationship between inward FDI and exports is found.
Liu et al (2002) investigate the causal links between GDP, FDI, exports and imports in China
with the methods developed by Johansen (1988) and Hall and Milne (1994). They show that each of
these variables with the tests proposed by Hall and Milne (1994). They also provide evidence to
support the presence of bi directional short run causal links between GDP, FDI and exports. But, uni
directional causal link can be found from GDP, FDI and exports to imports.
Liu et al (2001) examine the causal relationship between inward FDI and foreign trade between
China and 19 economies by using the Granger causality test during the period 1984 to 1998. The result
reveals that the growth of imports in China leads to the growth of inward FDI in China.
Khan and Leng (1997) examine the interactions among inward FDI, exports and economic
growth for Singapore, Taiwan and South Korea, at the aggregate level during the period from 1965 to
1995 by using Granger causality test. They claim that there is no evidence to support the causal
relationship between FDI and Exports in Taiwan and South Korea. Moreover, a one way causal
relationship which flows from exports to inward FDI is found in Singapore.

3.2. Studies analyzing the relationship between FDI inflows and Economic Growth
The empirical work so far has focused on the establishing the relationship between FDI and Economic
growth in the home country. However, work on Gulf Cooperation Council (Reyadh Y. Faras and
Khalifa H.Ghali, 2009), Ghana (Frimpong Joseph Magnus and Oteng Abayie Eric Fosu, 2008) and
Malaysia (Karimi, Mlhammad sharif and Yusop, 2007), all focused on the home country. These studies
take a range or methodological approaches, and find no reciprocal causality relationship between
economic growth and FDI.
The empirical and theoretical works have tried to establish the connection either between FDI
inflows and Economic Growth, between FDI inflows and Pollution or Pollution and economic growth.
A subset of these works has employed Granger Causality tests to determine the direction of causality in
one of these connections, for instance, FDI and Pollution: Hoffmann et al (2005); FDI and Economic
growth: Ericsson and Irandoust (2001); Chakraborty and Badu (2002) and Liu et al (2002); Pollution
and economic growth: Coondoo and Dinda (2002). But, limited to my knowledge, none of these
studies established the causal link of these three variables together.
Chakraborty and Basu (2002) explore the cointegrating relationship between net inflow of FDI,
real GDP, unit cost of labour and the proportion of import duties in tax revenue for India with the
method developed by Johansen and Juselius (1990). They find two long run equilibrium
relationships. The first relationship is between net inflow of FDI, REAL GDP and the proportion of
import duties in tax revenue and the second is between real GDP and unit cost of labour. They find
unidirectional Granger causality from real GDP to net inflow of FDI.
Ericsson and Irandoust (2001) use the test developed by Toda and Yamamoto (1995) and
Yamamoto and Toda (1998) to investigate the Granger causality between the annual growth rate of real
GDP per capita and the rate of change of FDI inflows for Denmark, Finland, Norway and Sweden.
They found that there is a bidirectional causal linkage between these two variables for Sweden, the
causality is from FDI growth to GDP per capital growth for Norway and there is no causality for
Denmark and Finland.

3.3. Studies Analyzing the Relationship between FDI Inflows and Trade
Nandita Dasgupta (2007) has studied the effects of international trade and investment related
macroeconomic variables, namely, exports, imports and FDI inflows and the outflows of FDI from
India over 1970 through 2005. Unidirectional Granger Causality was found from export and import to
FDI Out flows, but no such Causality exists from FDI inflows to the corresponding outflows from
India.
Zhang and Song (2000) demonstrate the performance of inward FDI on Chinese manufacturing
exporting at the provincial level during the period of 1986 to 1997. The result shows that FDI has a
strong influence on the export performance. Zhang and Felmingham (2001) examine the causal
relationship between inward FDI and export performance based on Chinas national and provincial
level from 1986 to 1999. The result reveals that there is a two way causality between inward FDI
and Exports at a national level. Similar results of bi directional causal relationship are demonstrated in
the coastal region and western China.
Mucchielli and Soubaya (2000) investigate the determinants of the volume of trade of the
French MNCs. The major finding suggests that inward FDI has a positive influence on foreign trades
(including Exports and Imports), and this positive influence is stronger for exports compared with
imports.
Eleanor Doyle (1999) has examined the Granger Causality procedure developed by Toda and
Yamamoto (1995) with particular focus on the role of Irish exports. Bi directional causality was
found for exports and output implying a virtuous circle of growth and exports.
Markusen and Venables (1996, 1998) expand the nature of the relationship between trade and
foreign direct investment concerning these differences among countries. They conclude that trade and
FDI coexist when countries are very differences among countries. They conclude that trade and FDI
coexist when countries are very different.

4. Data and Specification of the Model
The Granger Causality test used in time series analysis to examine the direction of Causality between
three economic series has been one of the main subjects of many econometrics studies for the past
three decades. We estimate the causal relationship between exports economic growth and foreign direct
investments. The Granger type test states that, if a variables x and z Granger Causes variable y, the
mean square error (MSE) of forecast of y based on the past values of three variables are lower than that
of a forecast that uses only past values of y. This Granger test is implemented by running the following
regression.
y
t
=
0
+

1
p
i
y
t-i
+
1
p
i
x
t-i
+
1
p
i
z
t-i
+
t

and testing the joint hypothesis H
0
:
1
=
2
=..
p = 0, and
1
=
2
=..
p
= 0 against H
1
:
..
0, and
1

2

..
0. Granger Causality from the variable y to the

coincident variables x and z is established if the null hypothesis of the asymptotic Chi Square (
2
)
test is rejected. A significant test statistic indicates that the x and z variables have predictive value for
forecasting movements in y over and above the information contained in the latters past.
The variable of economic growth (GDP) is measured by the real GDP. The variable is
measured by the foreign direct investment flows. The variable of exports is measured by the real
merchandise of exports. The data that are used in this analysis are annual, covering the period 1970-
2007 and are obtained from UNCTAD statistics 2008 and World Development Indicators CD ROM
2008.
All data are expressed in natural log in order to include the proliferative effect of time series
and are symbolized with the letter Ln preceding each variable name. If these variables share a
common stochastic trend and their first difference is stationary, then they can be cointegrated.
Also, the use of 1
st
differences in econometric studies facilitated the results interpretation, since
the first differences of natural log of initial variables represent the rate of change of these variables.
Which variables appear to have a stochastic trend and when these trends are common among
the examined variables as well. For the analysis of the multivariate time series that include stochastic
trends, the Augmented Dick Fuller (ADF) unit root test is used for the estimation of individual time
series with intension to provide evidence about when the variables are integrated. This is followed by
multivariate Cointegration analysis.

5. Unit Root Test
Tables 2 to 7 present the unit root tests for our Time series data. Lag lengths for the ADF tests are
determined by the Schwartz Information Criterion (SIC). This test results suggest that all series contain
a single unit root, which would require first differencing to achieve stationarity.
Prior to testing Cointegration and implementing the Granger Causality test, econometric
methodology needs to examine the stationarity for each individual time series most macro economic
data are non stationary, i.e. they tend to exhibit a deterministic and/or stochastic trend. A series is said
to be stationary if the mean and variance are time invariant. A nonstationary time series will have a
time dependent mean or make sure that the variables are stationary, because if they are not, the
standard assumptions for asymptotic analysis in the Granger test will not be valid. We should now
perform test for unit root in potentially nonstationary time series (Nandita Dasgupta 2007). The ADF
test is based on the following regression model that consists of running a regression of the first
difference of the series against the series lagged once, sum of lagged difference terms, and a constant
and a time trend.
y
t
=
0
+
1
t +
2
y
t-1
+
1
p
i
y
t-i
+ u
t

Where u
t
is the pure white noise error term, that adjusts the errors of autocorrelation and
independently and identically distributed.
y
t-i
= y
t-i
- y
t-i+1
.
y
t-i
expresses the first differences with p
lags. The coefficients
0
,
1
, and
i
are being estimated.
The ADF regression test for the existence of unit root of y
t
that represents all variables (in the
natural logarithmic form) at time t. The test for a unit root is conducted on the coefficient of y
t-1
in the
regression. If the coefficient is significantly different from zero (less than zero) then the hypothesis that
y contains a unit root is rejected. The null and alternative hypothesis for the existence of unit root in
variable y
t
is H
0
;
2
= 0 versus H
1
:
2
p
0. Rejection of the null hypothesis denotes stationarity in the
series.

6. Cointegration Tests
Having found that all the three variables in examination have unit roots (that is, they are integrated of
order one), our next step is to determine whether or not there exists at least one linear combination of
the non stationary variables that is integrated of order zero (I(0)).
Cointegration, an econometric property of time series variable, is a precondition for the
existence of a long run or equilibrium economic relationship between two or more variables having
unit roots (i.e. Integrated of order one). Two or more random variables are said to be cointegrated if
each of the series are themselves non stationary.
The results from the Cointegration analysis (see Table 8) show that when two lags are used, the
null hypothesis of no Cointegration (r=0) between LnEx, LnFDI and LnGDP is rejected at 5 per cent
level. This test may be regarded as a long run equilibrium relationship among the variables. The
purpose of the Cointegration tests is to determine whether a group of non stationary series is
cointegrated of not.
Cointegration test based on the Maximum Likelihood method of Johnsen (1979) suggests two
tests (the trace test and the Maximum eigenvalues test) statistics to determine the Cointegration rank.

7. Granger Causality
Table 9 provides the results of the long run relationship between FDI inflows, Exports and GDP for
India, the next logical step for our purpose is to examine the Granger Causal relationship among the
variables, x is said to Granger Cause y if and only if the forecast of y is improved by using the past
values of x together with the past values of y, then by not doing so (Granger 1969).
According to Granger causality test done by using annual data from 1970 to 2007 in India,
foreign direct investment (FDI) is not the causal exports. In other wards, there is causality relationship
from FDI inflows to exports. Economic growth (GDP) is not the cause of exports. In other words, there
is no causality relationship from economic growth to exports. Economic growth (GDP) is not the cause
of FDI. In other words there is no causality relationship from economic growth to FDIs.

8. Conclusion
This study examines the direction of the relationship between economic growth rate, FDI and Exports
by using Granger causality test. According to the results of the study, there is no reciprocal causality
relationship between these variables in India. The direction of causality relationship is from exports to
growth rate and there is no causality relationship from FDIs to exports. The directions of causality
relationship is from exports to growth rate and there is no causality relationship from growth rate to
exports, and the direction of causality relationship is from FDIs to growth rate and there is no causality
relationship from growth rates to FDIs.
In other words, FDI and exports in India is one of the factors affecting economic growth,
however, the high or low economic growth rate does not have an effect on the presence of FDIs and
exports in India.
Appendix-I

Table 1: Trends of FDI inflows, Exports, Imports and Balance of Payments in India.

(Millions of US Dollars)
Year
FDI
Inflows
A.G(in
per cent) Exports
A.G(in
per cent) Imports
A.G(in
per cent) BOP
Ex/Im(in
per cent)
1970 45 2026,4 2124,4 -98 95,38693
1971 48 5 2036,46 0,496447 2423,7 14,08868 -387,24 84,02278
1972 18 - 63 2447,94 20,20565 2223,24 -8,27083 224,7 110,1069
1973 38 113 2917,17 19,16836 3210,95 44,4266 -293,78 90,85068
1974 57 50 3926,4 34,5962 5135,88 59,94892 -1209,48 76,45038
1975 85 49 4355,12 10,91891 6380,66 24,23694 -2025,54 68,25501
1976 51 - 40 5548,79 27,40843 5664,95 -11,2169 -116,16 97,9495
1977 - 36 - 171 6378,2 14,94758 6646,63 17,32901 -268,43 95,96141
1978 18 - 150 6670,74 4,58656 7864,86 18,32854 -1194,12 84,81702
1979 49 168 7806,03 17,01895 9827,44 24,95378 -2021,41 79,43096
Average 45 1 4411,33 31,69 5150,27 40,29 -738,95 88,32315
1980 79 63 8585,54 9,985998 14864,4 51,25404 -6278,86 57,75908
1981 92 16 8295,3 -3,38057 15418,2 3,72568 -7122,9 53,802
1982 72 - 22 9357,88 12,80942 14786,1 -4,0997 -5428,22 63,28836
1983 6 - 92 9147,74 -2,24559 14060,7 -4,90596 -4912,96 65,05892
1984 19 241 9451,35 3,318962 15272,3 8,616925 -5820,95 61,88557
1985 106 451 9139,56 -3,29889 15928 4,293394 -6788,44 57,38046
1986 118 11 9398,96 2,838211 15421,1 -3,18245 -6022,14 60,9487
1987 212 80 11297,9 20,20372 16675,3 8,133013 -5377,4 67,7523
1988 91 - 57 13233,5 17,13239 19101,7 14,55086 -5868,2 69,27917
1989 252 176 15871,5 19,93426 20549,4 7,578907 -4677,9 77,23583
Average 105 24 10377,92 9,43 16207,72 4,25 -5829 63,43904
1990 237 - 6 17969,1 13,21614 23579,6 14,74593 -5610,5 76,20613
1991 75 - 68 17726,8 -1,34843 20447,8 -13,2818 -2721 86,69294
1992 252 236 19627,5 10,72218 23578,6 15,31118 -3951,1 83,24286
1993 532 111 21571,6 9,90498 22788,4 -3,35134 -1216,8 94,66044
1994 974 83 25021,8 15,99418 26842,7 17,79107 -1820,9 93,21641
1995 2 151 121 30630 22,41326 34706,9 29,29735 -4076,9 88,25334
1996 2 525 17 33105,1 8,08064 37942,2 9,321778 -4837,1 87,2514
1997 3 619 43 35008,1 5,748359 41431,9 9,197411 -6423,8 84,49552
1998 2 633 - 27 33437 -4,48782 42979,9 3,736252 -9542,9 77,79683
1999 2 168 - 18 35666,7 6,668361 46979,2 9,305047 -11312,5 75,92019
Average 1 517 91 26976,37 10,94 32127,72 11,03 -5151,35 84,77361
2000 3 585 65 42379,3 18,82036 51522,9 9,671727 -9143,6 82,25333
2001 5 472 53 43361,1 2,316697 50392,3 -2,19436 -7031,2 86,04707
2002 5 627 3 50372 16,16864 56516,8 12,15364 -6144,8 89,12748
2003 4 323 - 23 58962,9 17,05491 72557,7 28,38253 -13594,8 81,26346
2004 5 771 33 76648,6 29,99462 99775,4 37,5118 -23126,8 76,82114
2005 7 606 32 99619,6 29,96924 142842 43,16355 -43222,4 69,74111
2006 19 662 159 120861 21,32251 175242 22,6824 -54381 68,96806
2007 22 950 17 145431 20,32914 215500 22,9728 -70069 67,48538
Average 9 375 77,17 79704,44 34,74 108043,6 45,47 -28339,2 77,71338
Source: UNCTAD Statistics 2008, World Development Indicators CD ROM 2008.
Note: FDI= Foreign Direct Investment, A.G= Annual Growth Rate, BOP= Balance of Payment, Ex= Exports and Im=
Imports.
Appendix- II

Table 2: Results of Unit Root Test for Exports (Levels)

Null Hypthosis: LnEX has a unit root
Exogenous: Constant
Lag Length: 1 (Automatic based on SIC, MAXLAG=2)
Augmented Dickey Fuller test statistic t-statistic Probability*
-0.064521 0.9458
Test critical values: 1% level -3.626784
5% level -2.945842
10% level -2.611531
* MacKinnon (1996) one-sided p-values.

Table 3: Results of Unit Root Test for FDI (Levels)

Null Hypthosis: Ln FDI has a unit root
Exogenous: Constant
-0.634777 0.8499
5% level -2.948404
10% level -2.612874

Table 4: Results of Unit Root Test for GDP (Levels)

Null Hypthosis: LnGDP has a unit root
Exogenous: Constant
0.196228 0.9687
5% level -2.943427
10% level -2.610263

Table 5: Results of Unit Root Test for Exports (Differences)

Null Hypthosis: D (LNEX) has a unit root
Exogenous: Constant
Lag Length: 0(Automatic based on SIC, MAXLAG=2)
-4.215560 0.0021
5% level -2.945842
10% level -2.611531
Appendix- III

Table 6: Results of Unit Root Test for FDI (Differences)

Null Hypthosis: D (LNFDI) has a unit root
Exogenous: Constant
-6.110085 0.0000
5% level -2.954021
10% level -2.615817

Table 7: Results of Unit Root Test for GDP (Differences)

Null Hypthosis: D(LnGDP) has a unit root
Exogenous: Constant
-3.808292 0.0063
5% level -2.945842
10% level -2.611531

Table 8: Results of Cointegrating Relationships between Exports, FDI and GDP.

Hypothesed rank (r) Eigen value Likelihood ratio 5% critical value Probability
Race statistic for cointegrating rank
r=0 0.429783 21.54639 29.79707 0.3244
r 1 0.086908 3.009054 15.49471 0.9665
r2 0.000265 0.008752 3.841466 0.9251
Maximum Eigen value statistic for cointegrating rank
r=0 0.429783 18.53734 21.13162 0.1110
r1 0.086908 3.000302 14.26460 0.9467
r2 0.000265 0.008752 3.841466 0.9251

Mac-Eigen value test indicates no cointegration at the 0.05 level.

Table 9: Pair wise Granger Causality Tests.

Pairwise Garanger causality tests
Sample: 1970 2006
Lags 2
Null Hypothesis Obs F-statistic Prob
LNFDI does not Granger cause LNEX 33 2.26180 0.1229
LNEX does not Granger cause LNFDI 3.12072 0.0598
LNGDP does not Granger cause LNEX 35 0.26954 0.76550
LNEX does not Granger cause LNGDP 3.18567 .0552
LNGDP does not Granger cause LNFDI 33 1.53760 0.2325
LNEX does not Granger cause LNGDP 2.56760 0.0947

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International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 42 (2010)

0. Granger Causality from the variable y to the

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