Macroeconomic Determinants

Of Foreign Direct Investment in India

Introduction:
FDI has been one of the most debated and significant factor in the
economic development of the last 3 decades. In Asia, foreign direct
investment (FDI) has increased significantly over the past two decades.
However, this FDI has been concentrated in a few countries. In the
early 1990s, seven East Asian countries China, Korea, Singapore,
Indonesia, Malaysia, Philippines and Thailand received more than 60
per cent of the FDI inflows to the all- Asian countries. The BRIC report
[1] states that India is going to be one of the most popular destinations
for FDI from across the globe. However, the preliminary question still
remains whether this inflow of FDI is going to lead to any growth in our
domestic economy and exports, if yes how much and will it be
significant enough to drive further FDI inside the economy. Increases in
FDI inflows exceeded the growth in nominal value of World GDP and
international trade, which expanded by around 3.5 percent and 7
percent in 2006 respectively (World Investment Report, 2005).
Foreign direct investment can be defined as an investment which
involves establishing a long term relationship with the country where
the investment takes place and it reflects an intention of lasting
interest and control by the country which has made the investment. By
making a FDI, the home countries investor expects to get management
control and also a major say in the decision making process of the host
countries company. The inflow that takes place through FDI is not a one
time flow, depending on the interests and extent of profitability and
performance the home country may decide to reinvest/expand. The FDI
can come from individuals as well as companies. (World Investment
Report, 1997).
The components included to account the FDI values from country to
country.
Theoretical Background:
There are various the theoretical foundations that discuss the FDI:
(i)
Structuralist Paradigm:
Foreign investment is to be welcomed and actually encouraged
through tax concessions, etc. as a source of foreign finance and
technology. However, for Rural Prebish, such investment should
flow into the branches of production in which it is most needed
(Hunt, 1987).
[1] www2.goldmansachs.com/insight/research/reports/99.pdf
1

(ii)
Over Lapping Generations Model:
The overlapping Generations (OG) model is a long run growth model
and it gives a different perspective of the effects of foreign direct
investment on the home and host countries. The summary of the
finding is that this model gives is that when a country takes up the
foreign investment it makes the future generations of the country
which imports capital(host country) better off and the future
generations of the country that Exports capital(home country)
worse-off (Bhalla, 1994).
When a foreign investment takes place anywhere in the world, the
rate of interest increases in the home country and it tends to fall in
the host country. The capital stock of the previous generation
determines the wage levels of the present generation. It therefore
directly affects the savings made by the present and future
generations. The wage rate is assumed not to change. Therefore,
since foreign investment reduces the rate of interest in the host
country, according to the O.G. Model the present generation suffers
the effect of low interest rates. The rate of Interest increase in the
home country which exports capital, therefore, the present
generation of that country enjoys the fruits of high interest rates
(Roy, 1979).
(iii) OLI Paradigm:
The most recent of them all, is the one given by Dunning popularly
known as Eclectic or OLI paradigm. It discusses about ownership
(O), location (L), internalization (I) advantages of a countrys firms
differentiates along the countrys course of economic development
(Dunning, 1994), According to this theory, three conditions have to
be fulfilled in order for a firm to become a multinational: the
ownership (O) advantages must be such as to make it profitable for
the firm to relocate abroad its own production (or at least part of it);
there must be some localization (L) advantage, typically linked to
the host countrys specific characteristics; it must be more
convenient the firm to manage its advantages internally (I) rather
than trade them through the market. This appeared to be a very
useful paradigm in explaining the different characteristics that
needs to be fulfilled for a firm to be called a Multi-national and also
helped in developing further empirical workings on this topic. (Soci,
2002)
Review of Earlier Works:

Foreign capital inflows play an important role in supplementing and

complementing resources of developing countries in their efforts
towards higher levels of development. The role of foreign capital has
been emphasized in literature on economic development, for instance,
the gap models (Hunt, 1988) and the Kindleberger-Hymer Approach to
foreign direct investment.
It is Abba Learner who discussed at length about of inflow of foreign
capital (Lerner, 1944). The general effects of foreign investment on
development received a good treatment in the works of MAC Dougall
(Dougall, 1966). The work of Kemp (Murray, 1960) can also be
mentioned in this respect. However, the question of the possible
adverse effects of foreign capital on the levels of domestic saving was
first raised by Trygve Haavelmo (Haavelno, 1960).
Following
Haavelmo, many evinced interested in studies on the relationship
between foreign capital and economic growth in developing countries.
There was a proliferation of studies on this and the works of Lee, Rana
and Iwasaki in the context of Asia is important (Lee, 1986).
One of the earliest studies on the relationship between foreign direct
investment and growth is that of Papanak (Papanek, 1973). Among
country specific studies, the work of Gustav Ranis and Chi Shive on
Taiwan (Ranis, 1985) is very exhaustive. In 1970, it is Rober Aliber who
raised many theoretical issues like whether FDI is a currency area or
customs areas phenomena (Aliber, 1970). W.B. Reddaways analysis
(Reddaway, 1968) of influence of FDI on BOP is a land mark study in
the literature on FDI. A more general theory originally propounded in
a thesis at MIT by Stephen Hymer is that direct investment belongs
more to the theory of industrial organization than to the theory of
international capital movements. Hymers work emphasizes that firms
engaged in direct investment have monopolistic elements and the
perfect competition model is not relevant. To the literature on FDI, the
greatest contribution is made by Charles, P. Kindleberger (Kindleberger,
1958, 1968). His influence on subsequent works is profound that his
analysis and approach to FDI along with that of Stephen Hymer is well
known as Kindleberger Hymer Approach.
However, there are some region specific studies too, which helps in
understanding what are the FDI drivers at a very disaggregate level
and has useful implications at policy making level (Na, 2006). Others
talk about development of successful FDI strategies at national level
(Musila, 2006). Some simplistic papers look at just the trends of FDI in
various countries- what they expect to measure is the general
perspectives without exploring in detail what are the implications of
these investments on the national growth and other parameters. There
are studies pertaining to firm level analysis of the determinants
3

(Pantelidis, 2005), and the paper deals with specific determinants of

US FDI in India (Balasundram, 1998)

Objectives of the Present Study:

The main objective of this paper is to analyze the major determinants
of outward and inward Foreign Direct Investment (FDI) in India, such as
income, exchange rate, technology, human capital and openness of
the economy and determine which is more significant than others.
Hypothesis:
It is known through the theories specified above that the any asset of
the country keeps evolving over a period of time along with its
development and changes in the external environment especially the
economic policies. The firms in the economy also keep reacting to the
above changes and make suitable strategies of growth. The FDI which
flows in and out of the economy therefore must be a reaction and
dependent on these country specific parameters. Thus this paper tries
to evaluate the hypothesis that the FDI is a function of the factors
specific to a country such as Income, exchange rate, technology,
human capital and openness in the economy with specific reference to
Indian economy.
Period of Study:
A time-series data is taken for analysis, from 1980 to 2005 for analysis.
The model tries to identify the main determinants of FDI in Indian
economy.
Sources of Data:
Varied sources are taken for various parameters. Primarily the data on
FDI, exports, imports, interest rates, Exchange rates and GDP is taken
from Reserve Bank of India (RBI) online database of Indian Economy
and other annual publications on Indian economy by Reserve Bank of
India. The data for Human capital and the technology is taken from the
World Bank Reports and UNESCOs report of various years.
Methodology:
The model function is given below in the following form:
FDI = F(Y; I; ER; T; HC; O; D)
4

+ +
+ + -

+
+

+
+

+
+

+
+

Where,
FDI = Outward/inward flows of FDI.
Y = Real GDP.
I = Interest rate.
ER = Real Effective Exchange Rate (REER) Index.
T = Technology variable. This variable is reflected through the number
of patents issued in the home country.
HC = Human capital variable. It is approximated by number of
education students.
O = Openness of the economy. This variable is reflected by the level of
exports plus imports.
D = Dummy variable for measuring the impact of liberalization process
started in 1991 in the Indian economy: it takes the value 0 for the
years between 1980 and 1991 and the value 1 for the years between
1991 and 2005.
The signs given below the variables indicate the expected relation
(negative or positive) between the independent variables and FDI
outflows. The linear regression analysis is done using the OLS for the
period between 1980 and 2005.
The Model: Variables used and Explanations:
The dependent variable in the model is FDI of the given economy for
the period specified above.
There are several independent variables in the model namely Income,
exchange rate, technology, human capital and openness in the
economy. A brief explanation as to why these are considered as
variables in the model and why they are regarded as independent
variables supposed to have an influence on FDI is explained below.
1. Income: The first independent variable is GDP of the economy.
It is generally observed that the pattern of International Trade in
terms of the composition and direction changes with
development of an economy. There are changes observed in the
internal sectors also such as increasing share of industry and
service sectors, the capital intensity of production increases,
demand patterns move towards the consumption of
differentiated products and markets grow. The latter improves
the realization of economies of scale through specialization, the
introduction of new technology and greater volumes of output
(Chenery et al., 1986).
As the income of the nation increases there is always a
possibility that firms start accumulating advantages which are
5

owner specific or are resource specific. Thus the OLI advantages

as mentioned earlier gets created which attracts more FDI within
the country as makes the domestic economy more inclined
towards the external market (Dunning, 1993). Thus, it can be
said that as in case of trade the investment pattern also
undergoes a change with the development of the economy. Thus,
in this model, the GDP of the nation is taken as a variable to
measure the development and structural changes of the
economy over the period of study. It is expected as shown in the
model that there is a positive relationship expected between the
FDI and GDP indicating that as the nation advances towards
more development, the FDI inflows and outflows increase.
2. Exchange Rate: The appreciation and depreciation of currency
does have an impact on the price of exports and imports making
their comparative position and competitiveness in international
markets fluctuate sometimes towards advantage to the home
country and sometimes disadvantage. It was argued by (Aliber,
1970) that firms which come from countries that have strong
currency are able to financially support their foreign direct
investments in a much better manner than those firms which
come from countries that have a inherently weak currency. The
link between the interest rate and exchange rate also makes it
more beneficial for a firm to go in for a FDI as the currency
appreciates. Similarly the reduction in competitiveness of exports
also may make the country look for better ways of entering
international business. Thus, there appears to be a sure link
between the exchange rate and outward FDI, and the relation is
expected to be positive for outflows and negative for inflows as
shown in the model. The real effective exchange rate index of
the Indian economy which is calculated as a weighted average of
top currency basket is taken as a representative of the variable
exchange rate
3. Interest
Rate:
Foreign
operations
require
significant
commitment in capital, especially if they are undertaken in
capital intensive sectors where production is characterized by
extensive economies of scale, as the case is for most FDI. If
there is abundant capital in the home country, that may become
one of the primary reasons for going in for foreign investment by
large firms. Such firms would have adequate financial means and
they would also be able to access the capital markets much more
efficiently than small capital starved firms. The opportunity cost
of capital for such firms also comes down due to relatively low
interest rate which occurs as a result of capital abundance.
These firms are willing to take up the risks and uncertainties
associated with foreign investments because the returns on such
investments also being high (Krykilis, 2003). Therefore, it is
6

expected that if the interest rate of the home country is low, then
there would be high propensity for FDI inflows and vice versa
(Clegg, 1987; Prugel, 1981; Lall, 1980; Grubaugh, 1987).
4. Technology: This factor is widely recognized as one factor that
does have a sure and great impact on FDI, infact the FDI
sometimes may be the cause for increasing technological
progress as it also gets influenced by the level of technological
progress of the economy. Every firm across different countries
has its own ability to organize and produce technological inputs.
This depends on several parameters like the legal systems and
patent processes, the availability of technological inputs and the
requisite skills to handle it, the market structure, the policy of the
government related to education and the incentives that these
policies offer to encourage education, scientific research, etc. ,
(Krykilis, 2003). The ability of firms to generate technological
inputs of a country is approximated by the number of patents
issued. Thus higher the patents issued higher would be the
outward FDI propensity of the country. Researchers across the
globe have proved theoretically as well as empirically that
technological capability is positively related with FDI (Lall, 1980;
Prugel, 1981; Grubaugh, 1987; Clegg, 1987; Cantwell, 1981;
Cantwell, 1987; Pearce, 1989; Kogut and Chang, 1991; Dunning,
1993, Krykilis, 2003).
5. Human Capital: Some researchers proved that the skill
intensive sectors are more prone to attract the foreign direct
investment than the rest (Juhl, 1979; Lall, 1980; Prugel, 1981;
Clegg, 1987). The availability of the human resources is one
factor that plays an important role in determining the FDI;
however the sheer number does not affect the inflow as the
quality of the human resource does. The size of labour force may
be instrumental in determining the price of the factor, as low
labour cost may increase the cost competitiveness of the firm.
But in an skill intensive industry, the quality of the labour force
determined by the number of people who are educated and the
number of science and technology professionals that exist
matters. The human capital supply varies depends largely on the
education systems and also the government policies.
The
number of students both male and female who are taking up
higher level of education is taken as a variable to measure this
factor, as the data of R&D professionals in the Indian economy is
not available for continuous years for the period of study. Many
researchers showed that the higher the number of graduates, the
higher would be the expected skill content in the employment.
Thus, there is a positive relation that is suggested between
human capital and FDI (Krykilis, 2003).

6. The Openness of the Economy: The FDI activities of the firms

are constrained when there is protectionist policy followed;
therefore these activities are encouraged when the country
embarks on the path of liberalization. The reasons for this
change are many. The capital controls are relaxed which makes
the flow of capital and funds for investment between countries
easier and faster (Scaperlanda and Mauer, 1973; Scaperlanda
and Balough, 1983; Scaperlanda, 1992). The management skills
of marketing products internationally, innovations, technology
advancements and knowledge of external operations become
unrestricted in an economy that is export oriented. The firms of
an open economy may choose retaliate against the competition
that FDI has brought in by different modes and may also involve
themselves in the home markets of the import producing
countries. (Krykilis, 2003). The exports plus imports level of a
country is taken as a variable to represent this degree of
economies openness.
7. Dummy Variable: Dummy variable is taken for measuring the
impact of liberalization process started in 1991 in the Indian
economy: it takes the value 0 for the years between 1980 and
1991 and the value 1 for the years between 1991 and 2005.
Data Analysis and Results:
FDI is seen to increase as a percentage of the Gross Domestic Product
of most of the economies indicating the movement towards more
openness in the world economy. On the whole, FDI forms around 22
percent of the GDP of all the Economies of the world. As shown in Table
I, The developed countries are seen to be moving closely with the
World average. Whereas, the developing economies are seen to be
improving very fast and keeping the share steady in the recent years.
United Kingdom among the developed economies and Hong Kong,
China in the developing economies are the top destinations of FDI, as
seen in the Table, the economy of Hong Kong overwhelmingly
attracting Foreign Investments followed by Singapore and Vietnam in
East Asia. India is slowly picking up the speed as far as FDI is
concerned; it started with a meager 0.33 percent and is presently at
around 6 percent. Among the developing economies, all the continents
are faring equally as far as this parameter is concerned.
Foreign capital is treated as a resource gap-filling factor in the context
of capital scarcity in developing countries. In developing countries, FDI
is now the principal source of foreign capital. There are good reasons
to believe that FDI is preferred to other types of flows. One of the most
preferred arguments for FDI is that it brings in a complete package of
capital, technology and market access. It may also result in the
manufacturing sectors earning a potential competitive advantage
8

(Edward, 1992).
In those manufacturing sectors which enjoy
comparative advantage, the inflow of FDI would give rise to economies
of scale and higher productivity and create linkage effects (Edward,
1992) with FDI, profitability and outward remittance of profits and
dividends move in close tandem with the performance of the economy
and the balance of payments (Siow, 1993).
Coming to the scenario in Asia, few economies in this region are
attracting heavy inflows and others remain a low player. As can be
seen in the Table II, Asia contributes around one-fifth of the worlds FDI.
South, East and South-east Asia contributing almost four-fifth of the
total inflows destined in this region. However, there is a huge skewness
in favour of some economies in East Asia, with China dominating the
scene among all the economies. The internal policy framework and the
conducive environment for the foreign investors have been very fruitful
over the period for China. South Asia is among a deprived region in
entire Asia, with India contributing only around 3 percent to the regions
inflow in the year 2005. Singapore and Thailand are among other
economies in this region that attract a large inflow of Direct
Investments.
Take in Table I

Table I
Inward FDI Stock as a Percentage of Gross Domestic Product, by Host Region and
Economy, 1985 - 2005

6.44 8.92 9.67

13.1 13.8
9.97
3
5
14.0 17.6 19.2
6
2
2

199
7
11.7
6
10.3
6
15.2
2
19.0
7

199
8
14.0
1
12.4
7
19.0
7
23.7
3

North America

5.49 8.31 8.74

9.21

9.91

United States
Other developed
countries
Developing
economies

4.41 7.29 7.70

8.26

2.34 2.91
12.2
8.93
2
10.4 16.7
5
2
11.0
9.26
5
12.1
8.31
5

3.45
17.5
3
17.5
6
15.4
7
18.6
7

Region/economy
World
Developed
economies
Europe
United Kingdom

Africa
Latin America and
the Caribbean
Asia and Oceania

198
5

199
5

199
6
10.2
6.95 9.40
6

3.53
13.2
8
16.4
3
12.6
8
13.1
4

8.95

199
9
15.9
5
13.5
4
20.6
4
26.3
6
11.4
6
10.3
7

200
0
18.3
5
16.2
3
26.3
8
30.5
0
14.0
2
12.8
7

200
1
19.8
0
17.5
7
28.4
4
35.4
0
14.4
5
13.3
4

200
2
20.9
2
19.3
6
31.8
3
33.4
4
14.0
7
12.8
9

200
3
22.5
0
21.0
9
33.8
9
33.7
2
14.3
4
12.8
8

200
4
2005
23.3 22.6
0
7
22.0 21.4
5
0
34.9 33.4
4
8
33.3 37.1
2
0
14.5 14.5
1
6
13.0 13.0
3
2

3.93
20.5
7
19.3
2
18.6
6
21.9
5

4.35
25.9
1
26.9
8
24.2
9
26.5
6

3.94
26.2
6
25.9
9
25.8
4
26.5
1

4.40
28.0
7
26.5
6
31.8
2
26.3
7

6.02
26.7
4
29.8
2
33.9
9
23.3
0

7.29
27.7
7
30.4
0
36.7
8
23.8
8

8.15
27.9
3
29.9
4
37.6
4
23.8
8

7.32
27.0
0
28.2
0
36.6
5
23.1
5

Asia
West Asia
East Asia
China
Hong Kong,
China
Korea,
Democratic People's
Republic of
Korea, Republic
of
South Asia
India
Pakistan

12.1
8.26
2
11.3
2 8.02
12.2
8.24
6
14.4
2.04
4
75.2 50.0
4
7
..

13.1
1

18.6
6

21.9
5

26.5
7

26.5
1

26.3
7

23.2
9

7.80
13.1
9
15.6
9
51.5
2

8.31
23.2
7
17.1
4
143.
59

8.99
25.4
7
18.5
1
136.
21

8.88
34.0
4
18.7
8
252.
29

8.52
33.9
8
17.8
9
275.
44

9.66
33.3
4
17.2
8
257.
53

9.22
27.6
4
17.0
4
210.
25

9.80

10.3
1

9.98

9.83

9.45

2.74
4.14
2.54
12.7
4
12.2
4
27.4
7
14.5
7
42.2
8
10.2
3
78.3

5.56
4.70
3.33
11.7
9
12.7
3
47.2
2
32.6
8
62.4
4
14.2
8
105.

6.47
4.53
3.43
10.1
8
14.0
9
45.9
8
20.9
5
61.8
6
14.9
8
124.

7.32
4.66
3.77

13.3
6 6.57

2.24 1.83 2.06

0.91 2.54 3.27
0.33 1.54 2.11

Malaysia

3.01 7.27 9.36

10.1
8.84 9.95
6
13.4 22.6 24.6
6
3
2
10.1 11.7
6.71
7
7
23.6 32.3 35.7
8
4
2

Philippines
Singapore

8.46 8.21 8.89

60.0 78.2 81.4

Sri Lanka
South-East Asia
Indonesia

23.8
8
11.8
2
28.0
9
16.1
2
243.
39

23.8
9
11.3
8
28.3
4
14.8
8
275.
21

23.1
5
11.8
8
26.9
9
14.2
9
299.
88

8.58

9.17

10.0
9

10.7
0

8.58
4.78
4.20

8.11
5.45
5.00

7.94
5.62
5.18

8.24
6.04
5.68

7.97
6.23
5.84

9.78

8.25

9.80
45.4
2
16.5
0
58.4
0
16.8
7
121.

9.71
44.6
3
10.6
3
38.6
0
14.9
5
139.

8.29
10.4
4
43.6
5

8.48
10.7
2
43.8
4

8.77
11.3
1
44.1
6

8.78
10.4
1
43.2
0

4.11
39.4
5
15.6
8
153.

4.96
39.7
0
14.8
7
157.

7.05
37.1
9
14.9
2
156.

7.65
36.5
2
14.3
7
158.

Thailand

1
1
10.5 10.8
5.14
3
3
30.5 34.4 40.8
5
8
2

9
8.84
49.4
8

Viet Nam
South-East Europe
and the
Commonwealth of
Independent States
(CIS)
0.00 1.31 1.97 3.24
Source: World Investment Report 2006

83
22.7
8
57.5
1

23
25.3
7
63.3
9

67
24.3
7
66.0
7

95
28.7
9
70.4
3

20
30.0
9
74.3
1

55
33.9
6
70.4
4

19
32.9
5
63.5
4

57
33.5
0
61.1
7

5.40

8.64

15.8
7

19.4
9

22.1
5

24.4
5

23.8
0

21.2
2

Take in Table II
Table II
Inward FDI Flows, by Host Region and Economy, 1985 - 2005 (in US $ Million)

Asia
% of
World
West
Asia
% of
Asia
South,
East and
Southeast

1985
5421.
41

1990
22642.
36

1991
24154.
07

1995
79918.
01

1999
111285.
32

2000
147992.
76

2001
112044.
89

2002
96124.
85

2003
110136.
74

2004
156622.
32

2005
199553.
64

9.35
681.5
6

11.23

23.48
2495.2
1

10.12

10.50

13.46

455.69

15.60
2145.3
3

1799.49

3518.27

7219.71

15.56
6018.7
7

19.74
12313.5
3

22.04
18580.9
6

21.78
34460.7
5

12.57
4739.
85

2.01
22186.
67

8.88
22008.
74

3.12
77422.
80

1.62
109485.
82

2.38
144474.
49

6.44
104825.
18

6.26
90106.
08

11.18
97823.2
1

11.86
138041.
36

17.27
165092.
89

Asia
% of
Asia
East
Asia
% of
Asia
China
% of
Asia
Hong
Kong,
China
Korea,
Republic
of
Taiwan
Province
of China
South
Asia
% of
Asia
Banglade
sh
India
% of
Asia

87.43
2248.
30

97.99
8791.0
7

91.12
7944.1
1

96.88
46551.
57

98.38
77478.4
4

97.62
116275.
40

93.56
78828.5
9

93.74
67350.
24

88.82
72173.9
8

88.14
105074.
18

82.73
118192.
28

41.47
1956.
00

38.83
3487.1
1

32.89
4366.3
4

58.25
37520.
53

69.62
40318.7
1

78.57
40714.8
1

70.35
46877.5
9

70.07
52742.
86

65.53
53505.0
0

67.09
60630.0
0

59.23
72406.0
0

36.08
267.2
2

15.40

18.08

46.95

36.23

27.51

41.84

54.87

48.58

38.71

36.28

3275.0
7

1020.8
6

6213.3
6

24578.0
9

61924.0
6

23776.5
3

9681.8
8

13623.5
8

34031.7
0

35897.4
6

759.20

1130.3
0

1246.7
0

3042.8
0

3891.90

7726.90

7198.00

342.0
0
173.1
3

1330.0
0

1271.0
0

574.75

424.35

1559.0
0
2717.1
8

3.19

2.54

1.76

-6.66
106.0
9

3.24
236.6
9

1.39

1.96

1.05

217.9
0

9630.70

8650.60

3866.30

2926.00

4928.00

4109.00

3241.83

4658.30

3.40

2.91

75.00

1.90
2151.
00

0.31

2.69

453.00

1898.00

1625.00

6414.86

1445.0
0
6982.1
3

5729.27

7301.26

9765.05

3.15

5.73

7.26

5.20

4.66

4.89

309.12
2168.0
0

578.70
3585.0
0

354.50
5472.0
0

328.30
5627.
00

350.20
4585.0
0

460.40
5474.0
0

692.00
6598.0
0

1.95

2.42

4.88

5.85

4.16

3.50

3.31

Pakistan
Sri Lanka
SouthEast
Asia
% of
Asia
Indonesia
Malaysia
Philippine
s
Singapore
% of
Asia

47.44
24.40

278.33
43.35

271.92
67.00

492.10
65.00

532.00
201.00

309.00
172.95

383.00
171.79

823.00
196.50

534.00
228.72

1118.00
233.00

2183.00
272.00

2318.
42

12820.
85

13640.
28

28154.
05

28765.5
5

23540.7
9

19581.7
2

15773.
71

19919.9
6

25665.9
3

37135.5
6

42.76
310.0
0
694.7
1
105.0
0
1046.
75

56.62
1092.0
0
2611.0
0

56.47
1482.0
0
4043.0
0

25.85
1865.00

15.91
4550.00

17.48
2978.43

16.41

18.09

16.39

18.61

1896.00

5260.00

3895.26

3787.63

553.95

2473.16

4624.21

3967.12

556.00
4887.0
9

1247.00
16577.9
1

2240.00
16484.4
9

195.00
15648.8
7

145.09
3203.4
2
1542.0
0
7338.0
8

-596.92

550.00
5574.7
5

35.23
4346.0
0
5815.0
0
1459.0
0
11535.
31

491.00
10376.3
7

688.00
14820.1
1

1132.00
20082.7
3

9.42

9.46

10.06

1952.00

1414.00

3687.48

19.31 24.62 20.23 14.43

14.90
11.14
13.97
7.63
159.9 2575.0 2049.0 2070.0
Thailand
9
0
0
0
6091.00 3350.00 3886.00 947.00
Source: World Investment Report 2006 (percentages estimated)

Since the data used is time series and for over two and half decades, it
was checked for its stationarity and there was no stationarity observed.
The descriptive statistics of the data set is given in Table III, as it can
be observed that in India the Inflows of foreign direct investment in all
years have been much higher than the outflows, this aspect owes itself
to the liberalization policies which were put in place quite late in the
economy only after 1991 when they were initiated. The process of
integrating the domestic economy with the global economy though has
advanced over a period; it still remains partial in many cases.
Take in Table III
Table III
Descriptive Statistics
Mean
FDI In

Std. Deviation

9731.2081

12784.42419

57.8788

20.20889

361970.5485

152980.33055

ER

80.4319

16.60447

10.2885

1.89696

1774.1538

434.72876

6630645.1923

2982656.33152

58961.3462

42828.08604

FDI Out
GDP

Correlations between variables is estimated and shown in the Table IV,

the correlation coefficients are estimated using the Karl Pearsons
method. As can be observed that GDP shows a high level of correlation
with most of the variables whereas, the Exchange rate shows almost a
negative and weak relationship with most of the variables in the model
as is the case of Interest rates and technological development. Human
capital development and openness of the economy is closely and
positively related which is a good sign of economic progress.
Take in Table IV
Table IV
15

Correlations
REE
R

FDII FDIO

GDP

1.000

.969 -.033

.969

INT PATENTS EDN XM

-.71
6

-.010 .946 .978 .638

.963

1.00
-.62
-.213
0
5

.012 .944 .983 .708

ER

-.033 -.175

-.21
-.38
1.000
3
1

.272

-.25 -.12 -.63

7
3
7

-.716 -.613

-.62
1.00
-.381
5
0

-.233

-.55 -.62 -.10

8
9
5

-.010 -.052

.012

.272

-.23
3

1.000

-.06 -.05 -.30

5
1
8
1.00
.921 .724
0

FDII
Y

HC

.946

.977

.944 -.257

-.55
8

-.065

.978

.951

.983 -.123

-.62
9

-.051 .921

.638

.683

.708 -.637

-.10
5

-.308 .724 .687

1.00
.687
0
1.00
0

The regression results are shown in Table V, here the FDI inflows are
taken as dependent variable and other variables as independent. It can
be observed that the constant in the model is significant. It can be
seen that all variables except the exchange rate, interest rate and
technological factor is seen to have values as expected in the model.
However, this factor also shows no significance in the model. Though
the overall goodness of fit is very high and the Durbin-Watson statistics
does not show any signs of autocorrelation among the data variables,
surprisingly the exchange rate is not related to the inflows of FDI in the
Indian scenario possibly because it was controlled for a major part of
years in the period of study. The process of liberalization also shows a
positive and significant impact on the FDI flows, as seen by the results
of dummy variable, which should be a factor that the policy makers
should note and go ahead with further fastening of the pace of
relaxations of norms for FDI inflows in the economy.
Thus, it can be said that that Indian FDI inflows are mainly dependent
on the levels of openness and sectors of available for inflows rather
than major macro economic considerations such as exchange rates

16

and technological aspects. The domestic cost structures and the

availability of human capital in abundance and openness in the
economy seems to be a very significant factor to impact the FDI
inflows as can be seen in the model.
Take in Table V

Table V
OLS estimates of all variables in the model 1980-2005
Variabl
es

FDI In

Y
ER
I
T
HC
O
D

.009
117.898
-787.356
-.159
.002
.123
2388.20
0
13680.0
44
.996
671.048

Consta
nt
R2
F
statistic
DW

tstatistic
s
.740
4.758
-4.294
-.279
7.855
3.346
2.827
-2.941

1.768

The FDI outflow of the Indian economy has been largely restricted by
policies almost till the turn of the millennium. The regression results of
FDI outflows as a dependent variable can be seen in Table VI. As can be
observed that none of the variables are significant except the human
capital and most of the variables are showing reverse correlations as
against the expected signs in the model. Thus, the model can be
discarded as not relevant in Indian context as Indian liberalization of
FDI outflows has still a long way to go. This need to be tested further
when the liberalization process takes off in true sense and in a
complete manner.
Take in Table VI
17

Table VI
OLS estimates of all variables in the model 1980-2005
Variabl
es

FDI Out

3.73E005
.060
.003
-.002
4.46E006
4.74E005
-1.602
10.733

ER
I
T
HC
O
D
Consta
nt
R2
F
statistic
DW

tstatistic
s
.775
.608
.004
-.676
5.484
.323
-.474
.576

.976
102.471
1.584

Conclusions:
The exchange rate and economic growth seem to show least impact on
the FDI inflows in Indian economy and human capital and openness of
the economy plays a significant role as far as attracting inflows are
concerned. These results are exactly opposite to the findings related to
developed countries FDI determinants, where exchange rate and GDP
play a more positive and important role (Krykilis, 2003). This shows
that the liberalization process of the economy needs to be fastened
and more and more sectors should be thrown open for inward flows.
Similarly the model does not work for outward flows as in many cases
the flow is restricted by policy. Thus, it can be said that human capital
plays a significant role, which can be related to the abundance of
human resources at a competitive cost. Finally, national endowment
resulting in natural competitiveness does determine the FDI of Indian
economy.
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20

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Further Readings:
i)
ii)
iii)

Buckley, P.J. and Casson, M. (1976), the Future of the

Multinational Enterprise, Macmillan, London.
Buckley, P.J. and Casson, M. (1985), the Economic Theory of
the Multinational Enterprise, Macmillan, London.
Caves, R.E. (1971), Industrial corporations: the industrial
economics of foreign investment, Economica, Vol. 38, pp. 127.

Dr. G Bharathi Kamath

Assistant Professor
Economics Area

21

IBS-Mangalore,
Near Railway over bridge,
Padil
Mangalore-575007
phone:0824-2275838/848
Email: bharathi.g.shan@gmail.com

22