Foreign Direct Investment - A Catalyst For Economic Development of India

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:
1. Commercial Loan : are in the form of loan from foreign entity to business or government
2. Official Flow : are the assistance from World Bank, IMF or other developed countries to
developing Countries and LDCs
3. FPI: Foreign Portfolio Investment: are investment in instrument which are easily traded,
less permanent, and do not have a controlling stake in enterprise. In this category
investment are made via equity instruments (stocks) or debt (bonds) of foreign enterprise.
4. FDI : Foreign Direct Investment: Foreign direct investment (FDI) is defined as an
investment involving a long-term 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). Such investment involves both the initial transaction between the two
entities and all subsequent transactions between them and among foreign affiliates.1
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FDI means investment by non-resident entity/person resident outside India in the capital of an
Indian company under Schedule 1 of Foreign Exchange Management (Transfer or Issue of
Security by a Person Resident outside India) Regulations, 2000.2
FDI is capital flows in the form of investments from a parent firm to a location outside the
parent firms country of origin. Foreign Direct Investment includes intercompany debt apart
from equity 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. This concept
of control was developed by Hymer (1960) and is crucial to the distinction between portfolio
and direct investment as well as the motivation behind the firms investment.
Control is
usually defined as owning 10% or more of the voting shares.

Foreign Direct Investment (FDI) is always seen as important driver for economic growth in
the developing economies. FDI worked as important catalyst in economic growth of countries
like India. The interdependence of economic growth and Foreign Direct Investment (FDI) has
long been a subject of great interest for modern economist and policy makers. In current
volatile economic environment stable inflows of global capital emerges as an effective
channel to faster growth in developing countries.
The 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,
Human resource development
managerial skills development. FDI helps in improvement of exports and international trade.
The impact of FDI on economic growth depends on capacity of the host country to use FDI
efficiently. Similarly, trade liberalization may facilitate economic growth through efficiency
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in production by utilizing 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. Therefore, it is a challenge for developing countries like
India to find out the appropriate way to manage FDI and trade liberalization for economic
growth.
This paper is a modest attempt to examine the empirical relationship between FDI and
economic growth in India from 1991 to 2014. The 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. Since 1990 is the year from which the inflows of FDI started
entering on a significant scale on account of adoption of New Economic Reforms and Policy
of Liberalization in India.
FDI Policy 4
A foreign company planning to set up business operations in India may:
1.
Incorporate a company under the Companies Act, 1956, as a Joint Venture or a

Wholly Owned Subsidiary.
2.
Set up a Liaison Office / Representative Office or a Project Office or a Branch Office

of the foreign company
An Indian company may receive Foreign Direct Investment under the two routes as given
under:
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Automatic Route: FDI is allowed under the automatic route without prior approval
i.
either of the Government or the Reserve Bank of India

Government Route: FDI in activities not covered under the automatic route requires
ii.
prior approval of the Government which are considered by the Foreign Investment
Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance.
Foreign investment is reckoned as FDI only if the investment is made in equity shares,
fully and mandatorily convertible preference shares, fully and mandatorily convertible
debentures, Partly paid equity shares and warrants issued by an Indian company w.e.f. July 8,
2014
Any 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 equity or
does not involve upfront pricing of the instrument as a date would be reckoned as
ECB and would have to comply with the ECB guidelines.
THEORETICAL FOUNDATION
Production is function factor input and resources. Major 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 skills.
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However, 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 skills. Thus, 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 outward-oriented growth strategies. A number of studies have examined
the relationship between inward foreign direct investment (FDI) and economic growth in the
developing countries. A 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 package of capital, managerial skills, and technical
skills (Dattaray 2003).
TRENDS OF FDI INFLOWS INTO INDIA
The inflows of FDI into India were low during 1970 to 1980. During the period from 1980 to
1990, the inflows of FDI into India had grown considerably. Post 1992 when liberalisation
has started inflows of FDI into India had grown sizably during the period from 2000 to
2007.The value of FDI inflows has rose from 3.5 billion of US$ in 2000 and touched the
highest level of 43.4 billion of US$ in 2008. But due to global meltdown FDI inflow declined
in subsequent years and reached to 24 billion of US$ in 2012. In last two year with
improvement in economic condition FDI inflows reached to 34.4 billion of US$ in 2014.
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In billion US $
Source : world bank
Source : world bank
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Year
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
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GDP growth (annual

%)
1.66
7.25
5.71
-5.24
6.74
6.01
3.48
7.29
3.82
5.25
4.78
3.97
9.63
5.95
5.53
1.06
5.48
4.75
6.66
7.57
7.55
4.05
6.18
8.85
3.84
4.82
3.80
7.86
7.92
9.28
9.26
9.80
3.89
8.48
10.26
6.64
5.08
6.90
7.42
FDI growth (annual

%)
-25.37
367.92
-150.17
168.49
62.98
16.12
-21.58
-92.18
241.13
451.40
10.97
80.34
-57.02
176.27
-6.11
-68.93
276.01
99.04
76.84
120.25
13.18
47.45
-26.35
-17.69
65.28
52.67
2.82
-23.17
33.51
25.96
175.53
25.96
72.06
-18.03
-23.00
33.22
-34.26
17.33
22.23

Source : World Bank
GDP growth rate: Percentage change of real GDP compared to previous year. Real GDP is
adjusted for inflation.
Source : world bank

REVIEW OF RELATED LITERATURE
The 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. This conflicting nature of evidence is attracting more
and researchers to study the relationship between these two economic variables.
Matthew Tyler Lund in his research FOREIGN DIRECT INVESTMENT: CATALYST OF
ECONOMIC GROWTH? observed FDI as a composite bundle of capital stock and
technology, and can augment the existing stock of knowledge in the host economy through
labour training, skill acquisition and diffusion, and the introduction of new managerial
practices and organizational arrangements. New endogenous growth models allow FDI to
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impact economic growth in the long run through knowledge transfers from the MNE to the
host country. The 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. S.A. Saiyed (2012) in his work Effect of Foreign Direct Investment on Economic
Growth in India: An Empirical Investigation examined the causal relationship between
Foreign Direct Investment and economic growth in India. He observed strong positive
correlation between Foreign Direct Investment and growth of Gross Domestic Product.
Regressions analysis revealed that Foreign Direct Investment expansion has influenced
output variables; increase in Foreign Direct Investment causes annual output to increase. His
empirical work indicates that whatever may be the cause of rise in stock 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. Li and Liu (2005) in a panel data analysis for 84 countries over the period 197099
found that FDI affects growth directly and also indirectly through its interaction with human
capital. They also found a negative coefficient for FDI when it is interacted with the
technology gap between the source and host economies. This suggests that greater
technological differences between the source and host country hinders the host countries
ability to benefit from FDI. In a panel data framework for a sample of 18 Latin American
countries for the period 197099, Bengoa et al. (2003) found that FDI affects growth
positively. In order for a positive effect from FDI to be achieved, the country must have an
adequate level of human capital, economic stability, and liberalized capital markets.
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Though this is not an exhaustive survey of the literature that has gone into this area, I feel that
it does provide enough analytical frameworks for enabling us to undertake the present study.
OBJECTIVES OF THE PAPER.

To 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 1990-91 to 2013-14.
HYPOTHESES OF THE STUDY
Foreign Direct Investment is one of the important causes of accelerated growth in Gross
Domestic Product of the economy and subsequently increased economic growth in India.
DATA SOURCE AND METHODOLOGY
In this study, empirical analysis is undertaken 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 1990-91 to 2013-14 by applying
Computer software package, namely, MS Excel.
All these data are collected from the World Growth Indicators (WDI); data published on
website http://data.worldbank.org/country/india by the World Bank, World Investment
Report (WIR) published by the UNCTAD, Fact Sheet on Foreign Direct Investment (FDI) by
Department of Industrial Policy and Promotion (DIPP) and Handbook of Statistics on the
Indian Economy by RBI, Economic Survey (Government of India).
FDI - GDP Relationship:
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Here, to establish a relationship between Foreign Direct Investment and economic growth
(GDP) I applied Pearsons co-relation. In this study I also applied the Autoregressive model
to measure Foreign Direct Investment output relationships, as specified in two variable
models to establish causal relationship between FDI and GDP.
Two Variable Regression Model
Regression estimates covering period from 1990-91 to 2013-14 is presented with both
dependent and independent variables below.
Dependent Variable: Gross Domestic Product (GDP), Independent Variable: Foreign
Direct Investment (FDI)
Co-relation value of r=0.899 and r2 =0.808 shows a strong positive co-relation between
the two variables GDP and FDI
Liner Regression model for GDP = a + b* FDI
Where GDP stands for Gross Domestic Product year-wise and
FDI stands for the year-wise total Foreign Direct Investment of India
Regression results: (For 1990-91 to 2013-2014 data)
GDP=368.02+37.75*FDI
Significant at 5% level of significance
The above regression result supports the fact that the relationship between Foreign Direct
Investment (FDI) and Gross Domestic Product year-wise is significant and positive
Gujarat Co-relation value of r=0.719 positive co-relation between the two variables
GDP and FDI
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Karnataka Co-relation value of r=0.379 weak positive co-relation between the two
variables GDP and FDI
Maharashtra Co-relation value of r=0.566 positive co-relation between the two variables
GDP and FDI
CONCLUSION & POLICY RECOMMENDATIONS

The main objective 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 corelation 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.
Regressions analysis revealed that expansion of Foreign Direct Investment has a positive
impact on GDP, changes in Foreign Direct Investment causes annual output to increase. My
study reveals the existence of causality between Foreign Direct Investment and GDP. My
results indicate that rise in inflow of Foreign Direct Investment in India, whatever may be the
cause; 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, expansion
of capacities of existing manufacturing industries, project in the field of healthcare,
education, research and development (R & D) etc.
Government must design the policy to attract FDI in such a way that it can be utilized as
means of increasing domestic production, savings and exports through the equitable
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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 makers are looking 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 external and FDI.
1 definition as per UNCTAD (United Nations Conference on Trade and Development)

2 as per Department of Industrial Policy and Promotion Ministry of Commerce and Industry
Government of India Consolidated FDI Policy (Effective from April 17, 2014)
3 See Cohen et al.(1979) for a collection of Hymers essays.
4 https://www.rbi.org.in/Scripts/FAQView.aspx?Id=26
Reference :
1. Effect of Foreign Direct Investment on Economic Growth in India : An Empirical
Investigation by Dr. S.A. Saiyed, PARIPEX - INDIAN JOURNAL OF
RESEARCH, Volume : 1 | Issue : 11 | November 2012, ISSN - 2250-1991
2. Various FACT SHEET ON FOREIGN DIRECT INVESTMENT (FDI) by
DIPP,GOI.
3. HANDBOOK OF STATISTICS ON THE INDIAN ECONOMY
(http://dbie.rbi.org.in) by RESERVE BANK OF INDIA 2013-14
4. Consolidated FDI Policy (Effective from April 17, 2014) by Department of
Industrial Policy and Promotion , Ministry of Commerce and Industry ,
Government of India
5. Impact of Foreign Direct Investment on Indian economy by Mahanta Devajit
Research Journal of Management Sciences ,ISSN 23191171, Vol. 1(2), 29-31,
September (2012)
6. FOREIGN DIRECT INVESTMENT: CATALYST OF ECONOMIC GROWTH?
By Matthew Tyler Lund
7. Impact of Foreign Direct Investment Inflows on the Growth of Indian Economy
Deepak Kumar & Anupam, International Journal of Research (IJR), Volume-1,
Issue-5, June 2014
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Foreign Direct Investment - A Catalyst For Economic Development of India

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