Understanding the Determinants and Impacts of FDI

Inflows : An Indian Perspective

By:-

Jitender Singh

Student Id: -77102265

Under the supervision of: - Dr. Ashish Tripathi and Dr. Junjie Wu

Submitted in partial fulfilment of the requirements for the

degree MSc. Finance

Leeds Metropolitan University

2010-2011

i

Abstract

Purpose: The present study has been conducted to understand the determinants and

impacts of FDI inflows in india at macrolevel. However, the sub-objective of the research

is to find the economic variables that attract the FDI inflows in India at macrolevel and

to investigate the impact of FDI inflows in India at gross domestic product, gross capital

formation, import, export and domestic saving.

Methodology: In the present study, the ‘Positivism’ research philosophy is used as it

helps in constructing hypothesis by using theoritical and empirical literature, in

additiion, it involves the quantitative data and the statistical tools. As the present study

deals with the quantitative data, to provides the causual relationship between the

variables, test the hypothesis and followed highly structure methodology, the deductive

approach is adopted in the present study. However, the present study used the

quantitative technique in data collection and analysing the results. Furthermore, in the

present study the secondary data is used, the data is collected from the RBI’s ‘Handbook

of Statistics on the Indian Economy, 2011’, World Bank website and UNCTAD.

Furthermore, for examining the determinants and impacts of FDI inflows in India at

macrolevel, the regression model is used, in addition, the Pearson’s coefficient is used

for investigating the degree of relationship between the FDI inflows and economic

variables.

Findings: The present study found that the gross domestic product, import, export and

real effective exchange rate are the significant determinants of FDI inflows in India at

macrolevel. However, the regression coefficients of import and export are positive and

negative respectively. This signifies that the import attracts, while export deter the FDI

inflows in India at macrolevel which is not supportd by the literature. Furthermore, GDP

growth rate, gross capital formation, trade balance, Wholesale price index, openness of

the economy have found to be insignificant. In addition, the present study found that the

FDI inflows in India enhance the gross demestic product, gross capital formation,

import, export and domestic saving. However, the magnitude of the impact of FDI

inflows is much less than the impact of the gross capital formation on these variables,

including FDI inflows.

ii

Conclusion: However, from the results of the present study, it can be concluded that the

India still has not received the significant magnitude of the FDI so that it can significantly

impact the Indian economy.

Keywords: Foreign Direct Investment, Gross Domestic Product, Gross Capital

Formation, GDP growth rate, Import, Export, Trade Balance, Openness of the economy,

Wholesale Price Index, Interest Rate, Real Effective Exchange Rate and Domestic Saving.

iii

Acknowledgment

I would like to thank all the people who have supported me throughout the

preparation of this study.

I would really like to thank Dr. Ashish Tripathi (Supervisor, Bhopal) and Dr. Junjie Wu

(Supervisor, UK) for their continuous encouragement and support. I am really thank

full to them, for providing me with the relevant information and guiding me on this

research work.

I would also like to pay my gratitude towards my parents and my all dear ones for

their guidance and moral support which enabled me to come up with this study at

time.

At the end I would like to thank each and every one who has helped me directly or

indirectly for making this report.

Jitender Singh

M.Sc. Finance

2010-2011

iv

Table of Contents

List of Tables

List of Figures

Chapter 1: Introduction to the Study…………………….……………………………………………….1

1.0 Introduction ...................................................................................................................................................... 1

1.1 Background: Role of Foreign Direct Investment ............................................................................. 1

1.2 Significance of Present study .................................................................................................................... 2

1.3 Research Questions and Objestives ....................................................................................................... 2

1.4 Literature Review ........................................................................................................................................... 3

1.5 Methodology ..................................................................................................................................................... 5

1.6 Data Analysis..................................................................................................................................................... 5

Chapter 2: Theoritical and Empirical Review of Determinants and Impact of

Foreign Direct Investment.. ........................................................................................................ 7

2.0 Introduction ...................................................................................................................................................... 7

2.1Theoritical Review of Determinants of FDI........................................................................................ 7

2.1.1Theories Assuming Perfect Market................................................................................................. 7

2.1.1.1 The Different Rate of Return Hypothesis ........................................................................... 7

2.1.1.2 The Portfolio Diversification Hypothesis ........................................................................... 8

2.1.1.3 The Market Size Hypothesis .................................................................................................. 10

2.1.2 Theories assuming Imperfect Market ....................................................................................... 11

2.1.2.1 The Industrial Organisation Hypothesis .......................................................................... 11

2.2.2.2 The Internalization Hypothesis............................................................................................ 12

2.2.2.3 The Location Hypothesis ......................................................................................................... 14

2.2.2.4 The Electric Theory .................................................................................................................... 16

2.3 Review of Empirical Studies .............................................................................................................. 17

2.3.1 Review of the studies on the Determinants of FDI ............................................................ 17

v

2.3.2 Review of Impacts of FDI on Host Country ............................................................................. 22

Chapter 3: Research Methodology……………………………………………………..……………..…26

3.0 Introduction ................................................................................................................................................... 26

3.1 Methodology .................................................................................................................................................. 26

3.2 Research Philosophy .................................................................................................................................. 26

3.3 Research approach ...................................................................................................................................... 27

3.4 Research techniques .................................................................................................................................. 28

3.5 Data Collection .............................................................................................................................................. 29

3.6 Statistical Tools ............................................................................................................................................. 30

Chapter 4: Determinants and Impact of FDI in India ........................................................ 32

4.0 Introduction ................................................................................................................................................... 32

4.1 Variables and Data Collection ................................................................................................................ 32

4.1.1 Data Collection ...................................................................................................................................... 32

4.1.2 Explanatory Variables ....................................................................................................................... 33

4.1.3 Dummy variables................................................................................................................................. 37

4.1.4 Dependent Variable ............................................................................................................................ 37

4.2 Determinants of FDI inflows in India ................................................................................................. 39

4.2.1 Assortment of Significant Explanatory Variables ................................................................ 39

4.2.2 Assortment of Appropriate Functional Form of Regression .......................................... 39

4.2.3 Findings of the Log-Linear Multiple Regression equation .............................................. 41

4.3 Impact of FDI in India ................................................................................................................................ 43

4.3.1 Correlation Analysis ........................................................................................................................... 43

4.3.2 Simple Regression Analysis ............................................................................................................ 45

Chapter 5: Discussion of Results, Conclusion and Recommendations……………..…..53

5.0 Introduction ................................................................................................................................................... 53

5.1 Discussion of Results ................................................................................................................................. 53

vi

5.1.1 Determinants of FDI inflows in India at Macrolevel.......................................................... 53

5.1.2 Impact of FDI inflows in India at Macrolevel ......................................................................... 56

5.2 Conclusion ....................................................................................................................................................... 57

5.3 Recommendations ....................................................................................................................................... 58

5.4 Limitations of the Present Study .......................................................................................................... 59

Bibiliography…………………………………………………….………………………………………………...60

Appendices ..................................................................................................................................... 71

vii

List of Figures and Tables

List of Tables

Table 4.1: Log-Linear Multiple Regression Model of LFDI 41

Table 4.2: Pearson’s Coefficient of Correlation 44

Table 4.3: Impact of FDI inflows on the selected economic variables 45

Table 4.4: Impact of the Gross Capital Fromation on the selected economic

variables

46

List of Figures

Figure 4.1: Actual and Calculated FDi inflows, 1981-2010 43

Figure 4.2: Actual Flow of FDi inflows in India (Constant Price) 48

Figure 4.3: Gross Domestic Product of India (Constant Price) 48

Figure 4.4: Gross Capital Formation of India (Constant price) 49

Figure 4.5: Domestic Saving of India (Constant Price) 49

Figure 4.6: Import on India (Constant Price) 50

Figure 4.7: Export of India (Constant Price) 50

Figure 4.8: Wholesale Price Index of India (Base year 1993-94) 51

Figure 4.9: Interest rate in India 51

Figure 4.10: Real Effective Exchange Rate 52

1

Chapter 1

Introduction to the Study

1.0 Introduction

This chapter will introduce to the role of the foreign direct investment, significance of

the present study, research questions and objectives, literature review, methodology

and data analysis.

1.1 Background: Role of Foreign Direct Investment

Foreign direct investment is poliferating in developing economies after the countires

liberalized their polices concerning to FDI inflows and the working of MNEs from the

beginning of 1980s. India has opened its door for the MNEs to foster industrial growth of

the country and so MNEs have been authorized to enter in the core areas from the start

of 1990s. This is one of the vital reasons why the net inflows rose from 174 crores in

1990-91 to Rs.10,686 crores in 2000-01 which escalated the avearage growth rate at 6%

mark (RBI, 2001).

The policy makers of the India endeavoured to do all necessary activities to attract more

and more FDI. They were of opinion that the existence of the FDI in Indian soil would

escalate economic growth as through their large resources which they bring along with

them like capital and sophisticated technology. It is important to know that an increase

in National Income is based upon the volume of capital inflow and the ‘elasticity of

demand for capital’ which probably might strengthen the overall technological aspects

and managerial contributions thereby improving and stabilizing the condition of local

organisations.

The FDI inflows also swelled up in China after the accomplishments of the economy in

the post- Mao era (Sahoo, Mathiyazhagan and Parida, 2002). Experimental study

conducted by Xu (2000) discovered that the multinational of the U.S. are avenues which

promote the dissemination of global technology in 40 economies between 1966-1944.

The strong effects of dissemination can be experienced by the developing economies and

its feeble effects by the underdeveloped countries.

2

On the contrary it has been seen that the Foreign organisations somewhat affect the host

country adversely as these MNCs primarily penetrate in the economies with significant

entry restrictions and escalating market concentration (Grieco, 1986). In that situation

the foreign organisations might reduce the household savings and investment by pulling

out rent.

1.2 Significance of Present study

India has liberalized its economy is 1991, but still has not receive the significant

magnitude of FDI inflows. In addition, the magnitude of the FDI inflows in India is much

less than the other developing countries such as China, Brazil, Mexico, Thailand and

Korea (Sahoo, 2004). Furthermore, there are very few scholars who have studied the

determinants and impacts of FDI inflows in India such as Chakraborty and Nunnenkamp

(2006), and Sahoo (2004), but both the researches are now outdate, as after 2007, India

has gone through the global recession, the middle-east unsettlement and other economic

events. Then, it is necessary to again examine the determinants and impact of FDI

inflows in India at macrolevel as there are lot of changes in the economic conditions.

Thus, in this contest, the present study examine the economic variables and impacts of

FDI inflows on Indian economy.

1.3 Research Questions and Objestives

Research Questions

What are the significant determinants of FDI inflows in India at macrolevel?

What are the impacts of FDI inflows on Indian economy at macrolevel?

What are the impacts of gross capital formation on Indian economy at

macrolevel?

Research Objectives

To find the significant determinant of FDI inflows in India at macrolevel.

To examine the impact of the FDI inflows in India at macrolevel.

Sub-objectives:

To examine the impact of FDI inflows at gross domestic product of India.

To examine the impact of FDI inflows on gross capital formation of India.

3

To examine the impact of FDI inflows on Import of India.

To examine the impact of FDI inflows on export of India.

To examine the impact of FDI inflows on the domestic saving of India.

To examine the impact of the gross capital formation on Indian economy at

macrolevel.

Sub-objectives:

To examine the impact of gross capital formation at gross domestic

product of India.

To examine the impact of gross capital formation on FDI inflows in India.

To examine the impact of gross capital formation on Import of India.

To examine the impact of gross capital formation on export of India.

To examine the impact of gross capital formation on the domestic saving

of India.

1.4 Literature Review

The theories on the foreign direct investment are classified into two categories i.e.

theories of determinants of FDI and theories of impacts of FDI. Former elucidates the

various economic variables which determine the FDI, however these theories are further

classified into perfect and imperfect market theories. While the theories on the impact of

FDI elucidate the merits and demerits of FDI.

The perfect market theories are constitute of the differential rate of return (Hufbauer,

1975), portfolio diversification theory and market size theory. However, the first theory

assume that the FDI flows from the lower rate of return country to higher rate of return

country. Whereas, portfolio hypothesis assumes that MNCs want to reduce the risk by

diversifying their business, however this theory is a step up than the differential rate of

return theory as it considers the risk. While, risk reduction by diversification is not the

only motive of the MNCs, other factors also affect the FDI decisions of MNCs, however, in

perfect market theories, the third factor which affect the FDIs is the market size of the

country. This hypothesis has been widely accepted by the scholars and found to be a

major factor that affects the FDI flows. However, all the three theories have assumed the

perfect market, which is not practically possible, thus, this becomes their major

drawback.

4

On the otherside, the theories assuming the imperfect market are constitute of the

industrial organisation theory, internalization theory, location theory, electric theory,

product life cycle theory and oligololistic reaction theory. However, the product life cycle

theory and oligololistic reaction theory are not discussd as they are not relevant for the

present study. While out of the remaining four theories, electric approach of Dunning

(1977, 1979, 1980, 1988, 1998) is more advance, as this theory considered all the

parameters that are considered by the industrial organisation theory, internalization

theory and location theory separately. The ‘OLI’ hypothesis of the Dunning is widely

known, where ‘O’ stands for Ownership, ‘L’ stands for Location and ‘I’ stands for

Internalisation. However, this theory also have not considered all the variables that

affect the FDI flows.

As the theoritical review provied the limited number of determinant of FDI flows, these

determinants lonely cound not elucidate the flows of FDIs. Then the empirical literature

is excellent source of the literature on the FDI flows. The empirical literature provided

the more determinants than the theories, moreover, the empirical literature does not

assume the assumptions, otherwise which may raise concerm over the approach. The

empirical literature provided that the gross domestic product, GDP growth rate, gross

capital formation/domestic investment, openness, trade balance, and export of the host

country attract the FDI inflows in the country, while import, interest rate and inflation

deter the FDI inflows in a country. Whereas, the appreciation of the host country

currency deter the FDI inflows, while, the depreciation of its currency attract the FDI

inflows.

However, there have been no particular theory on the impact of the FDI inflows in the

host counrty, but there is lot of empirical literature on the impacts of the FDI inflows in a

country. The empirical literature is broadly categorized into two areas, some scholars

argued that the FDI inflows in a country enhanced the economic variables of the country

such as Chakraborty and Nunnenkamp (2006), Kumar (2007), Iqbal, Shaikh and Shar

(2010) and Ghazali (2010), while some scholars argued that the FDI inflows in a country

extract the resources of the country and damage the domestic industry . However, the

present study examined the impacts of FDI inflows on the gross domestic product, gross

captial formation, import, export and domestic saving of India at macrolevel and assume

that the FDI enhance these economic variables, these assumption as supported by the

5

findings of the Barrell and Holland (2000), OECD (2003), Sahoo (2004), Chakraborty and

Nunnenkamp (2006), Kumar (2007), Iqbal, Shaikh and Shar (2010), and Ghazali (2010).

However, the scholars provided the enormous amount of the literature on determinants

and impacts of FDI inflows in a host country, but still there is lack of literature on the

Indian economy, which can provide determinants and impact of FDI inflows in India.

1.5 Methodology

The present study has adopted the ‘Positivism’ research philosophy, as the study

considers the assumptions and involves quantitative data. In addition, the present study

adopted deductive approach, as there are already number of theories on the present

topic to construct assumption and a constructive methodology is applied. Furthernore,

the quantitative technique is adopded to examine the variables and analysing the

results. However, the study has collected the secondary data from the various sources,

thus it adopted the secondary data collection technique. At last, to examine the

determinants and impacts of FDI inflows, the statistical tools i.e. regression model and

Pearson’s correlation coefficient are adopted.

1.6 Data Analysis

The present study found that the gross domestic product, import, export and exchange

rate are the significant determinant of FDI inflows in India at macrolevel. However, the

presence of the gross capital formation and the interest rate enhanced the accuracy of

the regression model is predicting the FDI inflows, otherwise they have not found to be

significant. While, trade balance, wholesale price index, proxy of inflation and openness

found to be insignificant and excluded from the model to construct a appropriate model

for determining the FDI inflows. However, the results display the positive regresssion

coefficients for gross domestic product, gross capital formation, import and export,

which signifies that they attract the FDI inflows, while interest rate and real effective

exchange rate deter the FDI inflows. These findings are strongly supported by the

theoretical and empirical literature, except import, which was expected to deter the FDI

inflows as supported by the Kravis and Lipsey (1982) and Chen (1996).

The present study found the significant impacts of FDI inflows on the gross domestic

product, gross capital formation, import, export and domestic saving. It signifies that the

FDI inflows in the Indian economy act like a catalyst that enhance the economy of India.

6

However, the magnitude of the impact of the gross capital formation on the gross

domestic product, FDI inflows, import, export and domestic saving is much higher than

the impact of FDI inflows, which shows that still India has not enjoyed the benefits of the

FDI inflows.

7

Chapter 2

Theoritical and Empirical Review of Determinants and

Impact of Foreign Direct Investment

2.0 Introduction

This chapter is categorized into two sections, the first section constitute of the perfect

and imperfect market theories of determinants of FDI inflows in a country. While second

constitute of the empirical literature of the determinants of FDI inflows and its impact

on host country.

2.1Theoritical Review of Determinants of FDI

2.1.1Theories Assuming Perfect Market

2.1.1.1 The Different Rate of Return Hypothesis

This theory is based on the assumption that the FDI flows from countries with lower

rate of return to countries having high rate of return that eventually leads to equal rate

of return among the countries (Moosa, 2001, p. 24). This theory is originated from

traditional theory of investment, according to which firm’s main objective is to maximize

its profits (Agarwal, 1980). The principle of this theory in based on the assumption that

the MNCs consider that the FDI behaves in order to equate the marginal rate of return

and marginal cost of capital, however, this theory does not consider the risks related to

the investment and assumes that the investment decisions totally depend upon rate of

return; according to this approach, foreign direct investment and domestic investment

are perfect substitutes of each other (Moosa, 2001, p. 24).

However, to check the applicability of this theory, one has to investigate the relation

between FDI flows in different countries and the rate of returns in that countries

(Moosa, 2001, p. 24). In addition, Hufbauer (1975) argued that in fifties, this theory was

widely accepted when there was extreme amount of foreign direct investment to

Western Europe from America, where the rate of return in higher than America; but in

sixties this theory proved to be wrong as now the rate of return in America is higher

than the Western Europe but the FDI was continued to flow in Western Europe.

8

However, Stevens (1969a) found a relationship between rate of return and investment

but at regional level in Latin America not for any country. While, Moosa (2001, p. 24)

argued that the problem with this theory is that it assumed unilateral flows of FDI from

low rate of return to higher rate of return countries, but countries do experience

simultaneous inflows and outflows of FDI. Whereas, Bandare and White (1968) did not

obtain the significant relation between the rate of return and the flows of FDI in

European countries from America during 1953 to 1962 by using statistical tests but they

emphasized that return is a prerequisite for the investment. Similarly, Bandera and

Lucken (1972) also failed to detect the relationship between return and the distribution

of FDIs from America to European Economic Community and European Free Trade

Association via econometric tests. However, Hufbauer (1975) subtracted the foreign

countries’ rate of return and rate of asset expansion from domestic rate of return and

rate of asset expansion from 1955 to 1970 respectively and compared the two series but

had not found the significant relation between them. In addition, Agarwal (1980)

argued that some scholars included the query on return or profit motives during

interviewing and some of them obtained the positive answers; whereas some scholars

have not asked such questions to executives or managers during interviews but they

concluded that the expansion of businesses are indirectly to escalate profits. Whereas,

Moosa (2001, p. 25) argued that scholars use ‘Accounting rate of return’ on investment

for their studies, which is calculated on reported profit; the problem is that reported

profit is different from actual and expected profit, moreover accounting profit is affected

by many accounting procedures and factors which are not identical in different

countries. Furthermore, Agarwal (1980) also argued that the sale and purchase between

the parent company and its subsidiaries expected to be manipulated to reduce the total

tax of the company.

The major drawback of this theory is that it does not consider risk related to the

investments and moreover, it does not explain why a firms do not indulge in portfolio

investment rather than FDI (Moosa, 2001, p. 25).

2.1.1.2 The Portfolio Diversification Hypothesis

This theory considers one more variable i.e. risk related to investments, which do affect

foreign direct investment decisions of MNCs and makes the theory more realistic than

9

previous theory i.e. differential rate of return hypothesis (Moosa, 2001, p. 26). It

postulates that the investment decisions are not only depend upon rate of return but

also upon risk and it is positively related to rate of return and negatively related to risk

(Agarwal, 1980). This hypothesis is based on the theory of portfolio diversification given

by Markowitz in 1959, according to which an investor can reduces the risk by

diversifying its portfolio by adding more securities which are not perfectly correlated

(Moosa, 2001, p. 26). Similarly, a MNC can also reduces its risk by investing in different

countries, as the correlation of return on projects in different countries is less than the

correlation i.e. perfect correlation, of return on projects in same country (Moosa, 2001,

p. 26).

There are some economists who have endeavoured to test this theory such as Stevens

(1969b) who found a relationship among risk, return and direct investment in Latin

America at aggregate level in which only Brazil supported the portfolio hypothesis

where as Argentina and Mexico did not support it. In addition, Prachowny (1972), in an

endeavour to elucidate the demand for direct investment assets of foreign investment by

U.S and FDI in U.S., found more empirical evidence in support of portfolio hypothersis.

But, Agarwal (1980) questioned importance of the risk used as an explainatory variable

by Prachowny for FDI, moreover, he argued that the selection of empirical data was not

quite relevant. Whereas, Cohen (1975) suppported the theory by providing the

statistical results that showed minor variations in the global sale and profit of U. S. firms

which were extensively indulged in manufacturing activities abroad in sixties, however

he also stated that it could be the consequences of unintentional corporate decisions

taken for other motives. In addition, Rugman (1976) also supported the hypothesis as he

demonstrated that the MNCs enjoy the less risk in their sales and profits than a firm

operating in one market. He elucidated that the risk reduced because of the

diversification of the sales in different markets provided that they are not perfectly

correlated. But he also jotted that it does not fully explain direct investment, as it is only

the one variable. Moreover, he also explicated the possibilities of biasness in the result

because of the selection of U.S. MNCs which can conceal the sources of profits and

provide inaccurate net profits to minimize tax.

Overall, it appears that there are weak empirical evidence in support of the portfolio

hypothesis. But its significance is that it can be generalised (Prachowny, 1972).

10

Furthermore, it provides the reasonable elucidation for the cross investment among

countries and industries and it consider uncertainity; however, it does not elucidate that

why MNCs choose direct investment rather than portfolio investment and why they

contribute more to FDI (Agarwal, 1980). In addition, Ragazzi (1973) demonstrated that

in many less developed countries, the security markets are insufficient and not

organized; thus, the FDI is the only way of capital flow in such countries. Furthermore,

Moosa (2001, p. 27) jotted that FDI provides more degree of control than portfolio

investment to the MNCs. Moreover, Hufbauer (1975) also argued that it does not

explicate why some industries are more inclined to invest abroad than others and the

differences in tendencies cannot be only elucidated by return and risk.

However, Agarwal (1980) argued that the risk is estimated by the variance of rate of

return, which can be manupliated by the companies; albeit, it is not sure whether

investors have adequate data on previous return on assets or they are expecting the past

performance to be continue in future. However, it is superior to the differential rate of

return hypothesis as it accounts the risk.

2.1.1.3 The Market Size Hypothesis

According to this hypothesis, the size of market i.e. revenue generated by the MNC in

host country or host country’s GDP, attracts FDI; in other words, GDP is a function of

FDI. This theory is particularly focused on the import-substituting FDIs (Moosa, 2001, p.

27). This hypothesis is logical as the sales of firms increases, their investment also

increases and if the GDP of a country escalates, the investment also rises in that country

(Agarwal, 1980). In addition, Agarwal (1980) also jotted that the numerous studies on

this hypothesis are aimed to find the relationship between FDI and market size of the

host countries.

However, Bandare and White (1968) established a significant statistical correlation

between U.S. foreign investment in EEC countries and GNP and elucidated that there are

many motives for which investors invest in foreign countries. Similarly, Scaperlanda and

Mauer (1967) found the statistical relationship between U.S. FDI in EEC and their

market size for the years 1952-66. But Goldberg (1972) argued that the the market size

of EEC did not incline the U.S. FDI in EEC, according to him, the U.S. FDI in EEC were

because of the growth of the market. Whereas, Reuber, et al. (1973) demonstrated that

11

in least developed countries, the foreign investment on per capita and their GDP were

correlated, but there was not correlated with their GDP growth rate. Moreover, Reuber,

et al. (1973) also tried to find the relationship between the flow of foreign investment

and changes in GDP for an inverval for least developed countries, but had not

established any certain results. Similarly, Yang, Groenewold and Tcha (2000) was

unsuccessful in finding the association between flows of FDI and interval changes in

GDP; moreover, he eluciaded that the GDP growth rate may be considered to envisage

the potential growth of domestic market of host country and the economic development

of the host country may be represented by its per capita income.

But still there are many scholars who have used the real GDP as a determinants of FDI

and found significant correlation between them. As, Lipsey (2000) concluded that

inflows and outflows of FDI inclined to flow together in different countries; he

elucidated the inward and outward FDI and net flow of FDI by using nominal GDP as

size, real GDP per capita growth, real GDP per capita and percetage of gross capital

formation and GDP as size and growth variables. Furthermore, Love and Lage-Hidalgo

(2000) found the relationship between GDP per capita, explainatory variable, and U.S.

foreign investment in Mexico which makes GDP a more significant variable in

determining the FDI. However, Reuber, et al. (1973) argued that there is strong

correlation between FDI and GDP, but it is difficult to find out the direction of causality.

Whereas, Agarwal (1980) argued to take cautions to carefully interpretate the

relationship between FDI and market size as it assume the neoclassic theories of

domestic investment which are perpetually impractical; moreover, he also argued that

statistically it is difficult to differentiate between several type of FDIs.

2.1.2 Theories assuming Imperfect Market

2.1.2.1 The Industrial Organisation Hypothesis

This theory was introduced by Hymer in 1976, based on the assumption that subsidiary

of a foreign company established in another country confront some disadvantages in

tackling the competition from local firms. This include the cultural, language and legal

differences; also it is difficult to manage the operations that spreads out in different

places and analyzing the customers’ needs and preferences (Hymer, 1976). According to

12

Hymer (1976), in spite of these disadvantages, MNCs possesses some superiority over

domestic firms such as strong brand name, advance technology, effective managerial

skills etc.; the MNCs are advance in technology, they can produce better and new

products that differ from local firms’ products, in addition, the advance knowledge helps

them in managing the operation effectively like marketing of products.

According to Lall and Streeten (1977, p. 36), it is just not that MNCs have certain

advantages or they cannot sold their intangible assets to other companies; either

intangible assets are intrensic in an organisation or it is intricate to delineate, worth and

relocate. Albeit, MNCs want to sell their intangible assets, they cannot do so, including

their administrative capabilities, their reputation in the financial market, knowledge and

strength of executives and contracts with other organisations (Lall and Streeten, 1977, p.

36). These advantages to the firms justifies that why firms successfully compete in

foreign country. But this approach fails to explain why MNCs do not produce in the home

country and export to foreign market, which can be an alternative (Moosa, 2001, pp. 30-

31). Answer to this query, Kindleberger (1969) expalined that if the firms are already

operating in minimum cost then by producing additional goods for export would

increase their cost of production which indulge them into foreign investment rather

than exporting. Furthermore, Moosa (2001, p. 31) stated that MNCs can achieve low cost

of production in foreign country by procuring low-cost raw material, efficient

transportations, effective management, advance technology and superior Research and

Development department in home country.

The significance of this theory is that in the imperfect market, competing firms cannot

avail these advantages and MNCs can make enormous profits; moreover, these

advantages can easily transmitted from one place to another more effeciently, regardless

of geographically constraints (Sharan, 2008, p. 213). However, this theory elucidates

why firms do investments in foreign market but it does not explicate why a firm invest

in country A and not in country B.

2.2.2.2 The Internalization Hypothesis

Buckley and Casson introduced this theory in 1976; originally, they extracted this theory

from the work of Coase (1937), who believes that by establishing a new firm, a firm can

save transaction cost, otherwise, which is very high. This theory is accentuated on

13

imperfect competition because of the various costs associated with organized markets

and more emphasize on intermediate product markets’ imperfections (Buckley and

Casson, 1976, p. 33). However, Buckley and Casson (1976, p. 33) believed that firms

switch to internal market from external market to avoid time lags and save transaction

cost, which are entailed in the transfering the intermediate products for example

marketing, knowledge, management and human capital, which are imperfect in market.

MNEs transfer technology from one unit to another, normally at zero cost; which means

there is zero transition cost of transfering technology within infra-firm, otherwise such

costs usually exorbitantly high (Buckley and Casson, 1976, p. 34). The benefits of

internalisation, which are generated because of imperfect market, motivate firms to go

international, which eventually leads to FDI and firms continue to invest abroad untill

and unless marginal benefits equal to marginal costs (Buckley, and Casson, 1976, p. 34).

According to Buckley and Casson (1976, p. 34), the costs associated with internalisation

are communication and administrative expenses, whereas the various benefits of

internalisation are dodging of delays, negotiating and purchaser uncertainty, minimum

influence of government due to transfer pricing and the advantage of inequitable prices.

In addition, Buckley and Casson (1976) provided the reason why firms do not import

and export from foreign countries and invest overseas, furthermore, it elucidates why

firms are not willing to give licencing. The firms prefer intra-firm transactions rather

than market sales and purchases as they cause delays and transaction costs; moreover it

eradicate uncertainty (Buckley and Casson, 1976). However, the theory is criticised as it

is not necessary that the infra-firm transaction cost always be low; usually the

transaction cost is exorbitantly high, if the firms subsidiaries are established in

unpleasant environment (Sharan, 2008, p. 215). In addition, Petrochilos (1989) also

argued that it is not evident that whether excessive transaction expences, extended time

lags or something else should be termed as the inefficiency of the external markets,

which causes internalisation. However, it is worthful as it is a logical theory of FDI, but

theory does not applicable in short run, particularly to small firms which are indulge in

FDI in foreign countries; moreover, to empirically verify this theory is extremely difficult

(Agarwal, 1980). Similarly, Dunning (1977) strongly argued that firms retain their right

to utilize the innovations produced in their research and development departments,

since it seems more convincing as an innovator ables to earn enormous monopoly rents,

if he exclusively make use of his innovation for long time. Whereas, Rugman (1980)

14

argued that it is just a general theory which elucidate FDI but lacking empirical contents.

Likewise, Buckley (1988) was suspicious of it and argued that the direct test of the

hypothesis is not possible but he was expectant that from precise and rigorous tests he

obtains reasonable results. Whereas, Rugman and Verbeke (2003) pointed out that

internalization theory throughly consider the significant problems confront by the

managers of MNEs and even more than two decades, some of them remain imperative

for managers but the transfer of firm specific advantages by proper corporate planning

in different countries is now complicated.

Furthermore, Rugman and Verbeke (2003) argued that assumptions of internalisation

theory now need to be modified to examine the organizational structure of modern

MNCs such as limitation to the development of R&D concentrated MNCs, which are not

applicable nowadays; flow of knowledge is unilateral from parent companies to

subsidiaries, which is now often bilateral; the transfer of knowledge without any

hindrance across borders was glorified; decentralisation does not emerge from startegic

planning, it transpire without any strategic decisions and the role of subsidiaries in

innovations is barely considered.

2.2.2.3 The Location Hypothesis

The one of the most significant traditional determinant of FDI, the market size, has

diminished its significance; and the diversity in cost of production in different locations,

the condition of infrastructure, Openness and the quality of labour have gained

significance (UNCTDA, 1996). This theory is based on the hypothesis that some factor of

production are immobile which cause FDI to exist, then it is essential to consider the

cost of factor of production while selecting the location (Moosa, 2001, p. 33). But this

hypothesis is not only limited to factor of production, there are lot of other locational

factors that cause foreign investment such as the market, infrastructure, technology,

political stability, country’s law, social, cultural and corruption.

However, Riedel (1975) in his study on Taiwan found that the cheap labour is the

significant determinant of export FDI. While, Love and Lage-Hidalgo (2000) found that

the difference between the wages rate of U.S. and Mexico caused the FDI flows from one

nation to another. Similarly, Moosa (2001, pp. 33-34) jotted that wage rates of host

country and home country are a significant determinant of FDI, for example India

15

attracts labour-intensive investment in textiles and footwear industries; but he also

argued that high wage rate may point to high quality of labour then low wages do not

remain significant. Furthermore, Moosa (2001, p. 34) also elucidated that the labour

productivity is also significant, alone wage rate cannot be a reliable determinant.

Whereas, Yang, Groenewold and Tcha (2000) did not find the significant association

between low labour cost and FDI flows in Australia. While, Klein and Rosengren, (1994)

and, Barrell and Pain (1996) established that the high labour cost cause intensive

outflows of FDI and discourage FDI inflows. However, Lucas (1993) found that FDI and

wages are negatively correlated as the rise in wages in host country cause increase in

production cost, eventually, discourage production and FDI. Whereas, Yang, Groenewold

and Tcha (2000) argued that rise in wages may not escort the increase in labour cost

because in imperfect market, wages do not increase with productivity as it is not

necessary that the increase in the productivity totally point towards labour. While,

Moosa (2001, p. 35) pointed out that the increase in wages consequently rise the cost of

factor of production, which eventually leads to capital intensive approaches.

The advantages of locations are not only reflect by the low wages, there are also some

other factors that reflect locational advantages such as infrastructure, transportation,

policies etc.. As, Chiang (2010) studied the choice of FDI location in China at regional

level and demonstrated the positive relation with infrastructure and agglomeration

economies on FDI; moreover, his econometric model revealed that the regional policies

also affect the FDI. Similarly, Majocchi and Strange (2007) in their study on FDI location

choices in seven central and east european countries by Italian firms, demonstrated that

the size and growth of market, availability of labour, infrastructure and agglomeration

economies are significant variable of FDI location; in his findings, he jotted that FDI is

positively affected by extension of trade and financial liberalization, weakly positively

related to market liberalization and negatively associated to the openness to overseas

banks. In addition, Hong, Sun and Li (2008) have also examined the location

determinants of FDI in 29 Chinese regions using spatial econometric during 1990-2002

and found that the top five investors favour those provinces which have large market

size, proper transportation facilities, investment friendly policies, cheap per unit labour

cost, good labour quality and the investors invested in these regions from where their

home country is not too far. Moreover, Hong, Sun and Li (2008) also found that the

agglomeration economies attract high FDI form specific countries because of the

16

investment friendly packages or special zones for investment provided by regional

governments to attract foreign investment from particular countries or provisions. But,

the empirical studies cannot be universally applicable as the findings of Chiang (2010)

and Hong, Sun and Li (2008) are restricted to regional or country level, whereas

Majocchi and Strange (2007) use the sample of Italian SMEs for determining the location

variables in seven central and east European countries which may be that their finding

do not hold in other countries.

However, there are mixed evidences that locations affect FDI decisions, but, still this

hypothesis is significant in determining the FDI flows.

2.2.2.4 The Electric Theory

Dunning (1979, 1980, 1988, 1998) established Electric theory, in which he incorporated

industrial organisation hypothesis, the internalistion hypothesis and the locational

hypothesis. According to him, these conditions should be fulfilled in order to engage in

foreign investment. He argued that firstly, firms should have relative ownership

advantages because of intangible assets. Secondly, firms should have advantages of

using these advantages rather than selling or leasing them. Finally, Firms should receive

more profit for using these advantages in conjuction with aboriginal resources of the

host country; otherwise, it is preferable to export. Therefore, firms should have

ownership specific and internalization benefits, and host country should possess more

location advantages than home country. This theory is also known as ‘OLI’ hypothesis,

where ‘O’ stands for Ownership advantages, ‘L’ stands for Locational advantages and ‘I’

stands for internaliztion advantages.

However, Dunning (1980) jotted that it is easy to internalize ownership specific benefits,

if the firm possess more of them which attracts more foreign investment than domestic

investment. Furthermore, he added that there are two kind of inputs, first, which are

available in certain locations, but, available to all firms regardless of their size and

nationality such as national resources, labour quality, government policies etc. and the

second type of input are those which are created by the firms themselves or bought from

other firms, but they should obtain some proprietary right to use them such as

technology, patent etc.. In addition, Dunning (1980) elucidated that ownership benefits

ascertains which firm will operate in specific foreign country, while the location

17

advantages elucidated whether the firm should export to that country or should produce

in that country and the main benefits of internalization is to avoid price system and the

public authority fiat. Furthermore, Dunning (1980) also jotted that the firms prefer

internalization to avoid public interventions in the distributing the resources which

arises because of government policies of production, licensing technology, patent and to

avoid or exploit different tax rates and exchange rate policies. In addition, Dunning

(1988) explicated that MNEs may enjoy different ownership advantages because of their

different characteristics, products they manufacture, markets and competition.

However, the main advantage of the electric theory is that it provides answer to the

question that why the local firms do not able to meet the demand of a commodity, if they

are manufacturing it in home country and why foreign firms prefer to produce products

in host country rather than exporting them and if the firm want to diversify its

operations then why does not it uses other channels (Moosa, 2001, p. 36).

While, Ethier (1986) argued that internalization advantages are insignificant as compare

to the ownership and location advantages as determinants of the FDI. In reply, Dunning

(1998) argued that Ownership, Location and Internalization are critical determinants of

FDI as ‘O’ signify the advantages of firms, ‘L’ signify the location advantages and ‘I’

provide the explanation why firms prefer internalization for these benefits rather than

selling or buying the rights. However, Dunning (1998) suggested that there is need to

modify the earlier explanations of the electric theory, as now firm specific assets are

movable across borders, increasing significance of intangible assets and increasing trade

liberalization.

2.3 Review of Empirical Studies

2.3.1 Review of the studies on the Determinants of FDI

There are many scholars who have studied the determinants of FDI, but they have

provided diverse findings. However, most of the empirical studies support that market

size and market growth rate are the significant determinants of FDI flows. But it is

always the issue of debate that whether the market size is more appropriate or the

growth rate of market is significant determinant of FDI. However, Tsai (1994) jotted that

both the domestic market size and market growth were the significant determinant of

18

FDI, however, his study supported that market size was more significant determinant of

FDI than market growth. But, he developed a single model to examine determinants and

impact of FDI which raises concerns over his approach as it is not necessary that there

should be bilateral relationship between FDI and its determinants. In addition,

Nonnenberg and Mendonca (2004) found that FDI is correlated with average economic

growth rate in 38 emerging economies by executing an econometric model developed

by panel data analysis. Whereas, Barrel and Pain (1996) analyzed the factors that effect

the outward flow of FDI from U. S. by using an econometric model and found that market

size of the host country is the key determinants of FDI outflows. However, Azam and

Lukman (n.d) used GDP as a proxy of market size and found that it is positively

significant at 1 percent and 5 percent level of significance for Pakistan and India

respectively, but they have not found any significance for Indonesia.

Furthermore, some scholars also argued that trade openness/liberalization also a

signifiacnt determinant of FDI. Generally, trade openness measured as the sum of import

and export to the Gross Domestic Product (Dritsaki, M., Dritsaki, C. and Adamopoulos,

2004). However, Wilhelms and Witter (1998) used ‘Economic Openness Index’ for

economic openness and used it as an explanatory variable for econometric scrutiny for

determining the determinants of FDI. They found that the economic openness is the

significant determinant of FDI. But they have used four components, Parallel Market

Exchange Rate Premium, Free market, an open export regime and an open import

regime, for proxies for economic openess and valued them as dummy variables.

However, this method is acceptable if the countries have closed or open market,

restricted or liberal export and import regimes because it is easy to give ‘0’ or ‘1’ values;

but if a country has partially liberalized its economy, then it is difficult to consider

whether it is a open or close economy. While, Yang, Groenewold and Tcha (2000) used

trade to GDP as a proxy of openness to determine its effect on FDI flows in Australia and

established that degree to openness was negatively related to FDI flows. However,

Chakrabarti (2001) also investigate the significance of trade openness by defining trade

openness as aggregate of export and import to GDP and found that country's trade

openness is positively related to FDI and more significant than other variables. Similarly,

Sahoo (2004) investigated the importance of trade openness in India, but in constrast to

Chakrabarti (2001), he found that trade openness was not a significant determinant of

FDI inflows in India.

19

In addition, scholars also consider exchange rate as a significant determinant of FDI

flows. However, exchange rate hypothesis was introduced by Aliber (1970, 1971), who

argued that firms belong to having country strong currency inclined to invest in country

having relatively weak currency. Then, it is evident that the depreciation and

appreciation of currency plays an important role in determining the FDI flows. In this

context, Froot and Stein (1991) found a positive correlation between US dollar and FDI

flows in U.S. during depreciation of U. S. dollar which started in March 1985 by using a

simple regression analysis, but they have not found the similar result in other three

countries which were examined. While, Yang, Groenewold and Tcha (2000) also tried to

find out similar relation between effective exchange rate of Australian dollar and FDI

flows, but, they have not found any significant relation between them. Similarly, Mauro

(2000) has found variability of exchange rate did not impact the FDI decisions, although

he have not found the similar result for 1980s. However, Urata and Kiyota (2001)

argued that cash flow and profitability of a firm is affected by the volatility of exchange

rate and found that FDI flows from the country having strong currency to countries

having relatively weak currency. Furthermore, Khrawish and Siam (2010) in their study

on Jordon found that exchange rate stability is significantly and positively correlated to

FDI. However, the impact of the exchange rate volatility is more on export oriented firms

rather than firms which are seeking for host country market; then, the significance of

exchange rate as a determinant of FDI flows vary from firm to firm and country to

country.

The another factor which affect the decision of FDI is export. In this regard, Jun and

Singh (1996) argued that in addition to market size of a country, its export is also

significant determinant of FDI. They argued that many firms invested in other country

for export purposes and for dertermining in which country they should invest they

considered the export performance of the country. However, Kumar (1990), in his study

on Indian, has not found such a relationship between FDI and export, which means that

in India export is not a significant determinant of FDI. But, Sahoo (2004) found that

export was a significant determinant of FDI inflows in India at aggregate as well as at

sectorial level. In addition, Kravis and Lipsey (1982) and Chen (1996) argued that

import is also a determinant of FDI inflows. However, their notion was established on

the Kojima hypothesthey and argued that the import of the host country have a

significant impact on the activities of the MNCs. They argued that the import is the cost

20

determinant of the host country, which means if the country’s import is high, then it

signifies that the cost of production in the country is high, thus, such circumstances

deter the FDI inflows into that country. In contrast, Sahoo (2004) found that import is a

significant determinant of FDI inflows at sectorial level, but he also failed to found such

relationship at macrolevel. In addition, Sahoo (2004) also undertook trade balance as a

determinant of FDI in India but was not found significant relationship between trade

balance and FDI inflow in India.

In addition, inflation is also an important determinant of FDI in a country; as high

inflation signals economic instability in a country, then, it is negatively related to FDI

inflows (Schneider and Frey, 1985). In this regard, Onyeiwu and Shrestha (2004) found

that inflation is a significant determinant of FDI and negatively related to FDI in Africa

since 1975 to 1999 by using fixed and random sampling. As, Gopinath (1998) forcasted a

negative relationship between inflation and FDI inflow in India, Sahoo (2004) found a

negative relation between inflation and FDI in Indian economy; however, he used

Wholesale Price Index as a proxy of Inflation. In addition, he argued that inflation not

only increase the cost of production, it also reduces the demand. Then, it is

understandable that inflation is FDI is negatively related to inflation. While, Khrawish

and Siam (2010) found a positive relation between inflation and FDI in Jordan; however,

they used annual inflation rate as a proxy for inflation and argued that effect of inflation

on FDI flows in a country is depends upon its effect on the returns to the investors. But

generally high inflation in a country indiactes that the value of money in that country is

decreasing which inflated the prices of assets, raw material and even the cost of labour,

then it is obvious that an investor has to pay more money for wages, assets and raw

material, in that circumstances no investor want to invest in that country which is facing

high inflation.

However, interest rate is also an another important determinant for FDI flows. Gross

and Trevino (1996) found a positive relationship between FDI inflows and high real

interest rate in the host counrty than the home country because the foreign investor

raise funds at cheap interest rate in home country relatively to host country and invest

in host country. But, they argued that there could be a reserve relation if the foreign

investor has to raise capital in the host country’s financial market. However, it is

appropriate to use real interest rate difference between host and source country, when

21

one is analysing the determinants of FDI in host country from a particular foreign

country. Otherwise, it cannot be analysed as a determinant of FDI if one is analysing the

determinants of FDI in host counrty form number of foreign countries at aggregate level.

While, Lucas (1993) forecasted a negative relationship between interest rate and FDI

flows, he argued that interest rate is opportunity cost for an investment. In support to

him, Sahoo (2004) found a negative relation between interest rate and FDI flows in

India. He argued that the negative relationship between interest rate and FDI flows is

because of the extraction of funds from local market and purchasing of assets of firms in

Indian currency by foreign firms. He also argued that in such circumstances when the

oppurtunity cost in host country is high, it is difficult for foreign investors to raise funds

which eventually cause decline in FDI inflows.

However, some scholars also claim that domestic investment of the host country is also

an important determinant of FDI inflows in host country. In this context, Ghazali (2010)

found high degree of positive correlation between domestic investment of Pakistan and

FDI inflows. He argued that the domestic investment signifies development of

infrastructure and sent a message about the investment climate in the country to foreign

investors. However, Sahoo (2004) also investigate domestic investment as determinant

of FDI in India, but he has not found significant relationship between them. While, Desai,

Foley and Hines (2005) found a strong association between domestic investment and

foreign investment.

Some scholars also agrued that social-political stability of a country also affect the

inflows of FDI. In support, Wang and Swain (1995) consider particular political events

those may impact the FDI and used them as dummy variable. In addition, Chan and

Gemayel (2004) also examined the risk of instability and the flow of FDI in Middle East

and North African regions and established that risk of instability in the region

discourage FDI inflows in the region, which are generally instable than developed

countries.

In addition, there are lot of determinants that affect the FDI flows in an economy like

Altomonte (2000) argued that strong property rights and patent rules are the

prerequisite of FDI in a country. In support, Smarzynska (2004) also argued that

investors do not prefer to invest in those countries where Intellectual Property Rights

are weak, especially in high-technology industry. In addition, tax rates also have

22

significant impact on FDI flows in an economy. Whereas, Hines (1996) investigated the

International Tax and FDI flows through survey data attained from commerce

department of U. S. and established that there was a negative relation between high tax

rates and FDI flows. In addition, Slemrod (1990), Wilhelms and Witter (1998),

Carstensen and Toubal (2004) and, Demirham and Masca (2008) also support that high

tax rates have negative affect on the flow of FDI.

The above review of literature reveal that there are number of determinants of FDI

flows. However, there is famine of literature on determinants of FDI in India at

macrolevel. However, Kumar (1990), Gopinath (1998), Chakrabarti (2001), Sahoo

(2004) and, Chakraborty and Nunnenkamp (2006) provided some literature on India at

macro level. Though, there are several scholars who have done empirical studies on

other economies and examined the determinants of FDI inflows at macro level. As the

scholars have provided the number of determinants, the above empirical literature

corroborate that market size, market size growth rate, openness, exchange rate, export,

import, trade balance, inflation, interest rate, domestic investment and social-political

stability as the key determinants of FDI inflows in a host country.

2.3.2 Review of Impacts of FDI on Host Country

Some research established that only developed countries enjoy the benefits of FDI

(Borensztein, Gregorio, and Lee, 1998) while some scholars has argued that FDI only

benefited developing countries (Bloningen and Wang, 2004). Whereas, Jensen (2006) by

reviewing the literature argued there the impact of FDI on an economy generally differ

among scholars’ researches, however his conclusion cannot be accepted for other

economies as his review of literature is limited to transition countries. While, Tsai

(1994) established that the impact of FDI differ geographically and periodically.

Furthermore, Kumar (2007) jotted that foreign capital has potential to carry massive

advantages to the host country, he argued that it has demonstrated that FDI flows are

effectual in endorsing growth and production in countries which have sufficient talented

labour and infrastructure. In addition, Ghazali (2010) established that there was

unilateral relation between FDI and GDP growth rate of Pakistan from FDI to GDP

growth rate. Similarly, Iqbal, Shaikh and Shar (2010) also found that FDI enhanced the

economy growth of Pakistan, but they established a bilateral relation between FDI and

economy growth. Whereas, Chakraborty and Nunnenkamp (2006) in his study on India

23

has argued that the quality of foreign investment matter for growth of host country

rather than volume of FDI, however he also argued that the effect of FDI on growth may

vary from industry to industry and country to country because it depends upon the

various factors like technology spillovers, quality of labour, absorption capacity of

labour, export orientation and bond between foreign and local firms differ

geographically and among industries. While, Hermes and Robert (2003) studied the 67

countries and found that in 37 counrties FDI enhace the economic growth; however, he

elucidated that it is not necessary that the FDI enhance the economic growth of a

country, he argued that the FDI only contribute to economic growth in those countries

which have developed financial system. Furthermore, OECD (2003) explicated that the

FDI enhanced the economic growth by enhancing the productivity of factors and

improving the efficiency of resources. However, OECD (2003) argued that the impact of

FDI on the growth of least developed countries was less as compare to other developing

countries because of lack of education, infrastructure and technology, it also jotted that

it is difficult to determine the magnitude of the impacts. Whereas, Chadee and

Schlichting (2007) in their study on Asia-Pacific region found that impact of FDI varies

from country to country depends on the concentration of the FDI in sector. They found

that FDI significantly enhanced the economic growth in countries where FDI flow is

enormous in tertiary sector, while there was no effect on the economic growth of the

countires where the FDI is concentrated in primary sector (Chadee and Schlichting,

2007).

However, Barrell and Holland (2000) argued that FDI produces enormous benefits to

the host country as it brought huge capital in the host country economy and most

significantly the knowlegde which it brought to change the technology in the host

country and enhanced its economy. In addition, Dritsaki, M., Dritsaki, C. and

Adamopoulos (2004) have argued that both the emerging and developed countries have

benefited from FDIs, particularly by technology and management proficiency which

were spillover by multinational companies. Furthermore, Bosworth, Collins and

Reinhart (1999) also jotted that foreign investments transfer technology and managerial

skills to developing countries which accelerate their economic growth. Similarly, OECD

(2003) also supported the above arguments and jotted that the involvement of foreign

firms in host countries’ business promote technology transfer. Whereas, Potteri and

Lichtenberg (2001) has done an econometric analysis on transfer of technology across

24

borders in thirteen industrilized countries through inward and outward FDIs. While,

they found that the inward flows of FDI has not contributed to technology enhancement

in host country; whereas, outward FDI contributed more R&D benefits to large countries

than small countries. However, Potteri and Lichtenberg (2001) study was concentrated

of thirteen industrilized countries, then it may not be applicable on developing countries

because these countries are less advance in technology that developed countries,

therefore in developing countries the main advance technology contributor should be

foreign firms from developed countries. Furthermore, Sahoo (2004) studied the impact

of FDI on Indian GDP and found bi-directional causality relation between them, which

signifies that both FDI enhance GDP of India and vice versa.

Moreover, some scholars also claim that FDI flows affect domestic investments and

domestic savings. However, Ghazali (2010) found that there has been a bidirectional

causality between flow of FDI in Pakistan and its domestic investment. He argued that

inflow of FDI in Pakistan enhance and complement the domestic investment. While,

Bashier and Bataineh (2007) established that causality relationship between FDI and

domestic saving in Jordan from FDI to net domestic saving, which signifies that FDI

enhance domestic saving. In addition, Bosworth, Collins and Reinhart (1999) have

studied the impact of capital flows on domestic saving and investment in 58 developing

countries by regression analysis and found that FDI has great impact on investment and

saving in emerging economies than their full sample of countries. However, this finding

is not clearly stated and discussed, as their study was based on capital flows, which

include FDI, portfolio investment and loans; moreover, they are not focused on

developing countries as they have included industrial countries in their full sample.

However, OECD (2003) also argued that FDI is positively related to domestic investment

and saving, but it has not performed the statistical test for the above finding, they simply

develop a chart in which they used the percentage of FDI to GDP, percentage of domestic

investment to GDP and percentage of domestic saving to GDP. While, Katircioglu and

Naraliyeva (2006) found bidirectional causation between domestic saving and FDI by

adopting Granger Causality Test, however, they have not found co-integration between

FDI and domestic saving through Johansen Co-integration Test. However, the impact of

FDI on the domestic investment and domestic saving in India was studied by Sahoo

(2004), who found bidirectional relation between FDI and domestic investment, which

25

means both complement eachother; but, he found unidirectional relation from domestic

saving to FDI.

However, many scholars argued that many MNCs choose a location for export purposes

because of its locational advantages. In addition, several latest empirical studies have

established that FDI enhance export of the host country (UNTACD, 2002). Furthernore,

Njohg (2008) established that the export of Cameroon has enhanced by the subsidiaries

of MNCs as they produce the products at low cost to sustain their export

competitiveness in international market. While, Iqbal, Shaikh and Shar (2010) found a

bidirectional causality relationship between FDI and export in Pakistan, which signifies

that FDI inflows have significant impact on the export and trade of Pakistan. However,

Sahoo (2004) has found a unidirectional relation form export to FDI, but not from FDI to

export in India

The above review of empirical literature on the impacts of FDI on host country reveal

that FDI affect the host country. However, its impact and magnitude vary from country

to country. In addition, very few research have been conducted on the impacts of FDI on

India at macrolevel.

26

Chapter 3

Research Methodology

3.0 Introduction

In this chapter the research methodology, philosophy, approach, technique and data

collection technique are discussed and in addition, this chapter also discussed which

research philosoply, approach, technique and data collection technique is adopted in the

present study. At last, the statistical tools that are applied in the present study are

discussed i.e. multiple regression, simple regression and pearson’s coefficient of

correlation.

3.1 Methodology

The term methodology is refers to theory of how research should be perform (Saunders,

Lewis and Thornhill, 2011, p. 3). It provides the analytical way to resolve the research

dilemmas. Research methodology usually gives answered of many questions like why

research study is undertaken, how the research problems has been defined, what data

has been collected, which method is implemented, why particular technique of data

analysing has been used (Kothari, 2004, p. 8).

3.2 Research Philosophy

The research philosophies enclose important assumptions which will support the

research strategy and the methods which are selected as a part of strategy. Johnson and

Clark (2006) emphasis on philosophical commitments that contains what we do and

what it is we are investigating. According to Saunders, Lewis and Thornhill (2011, p.

108) the research philosophies are categorized into three parts:

Positivism

In this philosophy data should be collected by using existing theory to develop

hypothesis. It is highly prepared in order to make possible duplication (Gill and Johnson,

2002, cited in, Saunders, Lewis and Thornhill, 2011, pp. 113-114). This philosophy gives

prominence to quantifiable observations that leads to statistical analysis (Saunders,

Lewis and Thornhill, 2011, pp. 113-114).

27

Realisms

It is related to scientific questions, which is that there is a reality quite independent of

mind. It is the part of epistemology which is relatively similar to positivism in that

assumes scientific approach to development of knowledge. This includes the assumption

of collecting the data and understanding the data (Saunders, Lewis and Thornhill, 2011,

p. 114).

Interpretivism

In this philosophy the researcher has to implement empathetic attitude and need to

identify the difference between humans in our role as social actors. The researcher has

to enter into the social world for research subject and understand their world according

to their opinion (Saunders, Lewis and Thornhill, 2011, p. 116).

Philosophy adopted in the present study

Positivism is most appropriate approach for this study because it will help in generating

assumption by using theoritical and empirical literature. In additiion, it involves the

quantitative data for statistical analysis.

3.3 Research approach

Based on necessity of the research, decision should be taken about the kind of study to

be performed. It is also relied on type of reality; the fittest research approach should be

selected. The modelling research obtains best result through a model that comprised

objective functions and constraints (Panneerselvam, 2009, p. 12). According to

Saunders, Lewis and Thornhill (2011) there are mainly two types of research

approaches:

Deductive approach

This approach directs to develop the theory and hypothesis and design a research

stretegy to test the hypothesis. It is a scintific principle approach, moving from theory to

data. It involves the development of theory that is subjected to be regorious test

(Saunders, Lewis and Thornhill, 2011, p. 124). Robson (2002) provides five progress

steps of deductive approach which are; assumption of hypothesis, articulate the

hypothsis in operational term, testing of hypothesis, examination of specific outcomes,

28

and alteration of theory in light of results, if required (Saunders, Lewis and Thornhill,

2011, p. 124).

Inductive approach

In this aaproach the data would collected to develop the theory as a results of data

analysis. Inductive approach owes more to interepretivism philosophy. Its a collection of

qualitative data and it is less concern with the needs to generlise. (Saunders, Lewis and

Thornhill, 2011, p. 124).

Approach adopted in the present study

This study reqires deductive approach because of main reasons like it is deals wih

quantitative data, provides the causual relationship between the variables, control and

allow the testing of hypothesis, involves use of highly structured methodology, concept

which operationalised in a way that enables facts to be measured quantitatively and

allow generalisation of statisctics in selected saample of sufficient numerical sizes

(Saunders, Lewis and Thornhill, 2011, pp. 124-127).

3.4 Research techniques

There are several methods alternatives which combines with data collection techniques

and analysis of procedures. Primarily there are two data collection techniques

quantitative techniue and qualitative technique which are used in business and

management research to differantiate data collection techniques and data analysis

(Saunders, Lewis and Thornhill, 2011, p. 151).

Quantitative techniques

It is used as synonym for any data collection techniques such as questionaire or data

analysis procedure such as graphs or statistics that uses numerical data (Saunders,

Lewis and Thornhill, 2011, p. 151).

Qualitative techniques

This technique involves data collection from technique like interview and data analysis

procedure through catogorising non-numerical data. It also includes data which are

29

other than words like pictures and vidio clips (Saunders, Lewis and Thornhill, 2011, p.

151).

Technique adopted in the present study

The research is performed by using statistical tools and models therefore, this research

is completely involves the quantitative techniques in data collection and data analysis

(Saunders, Lewis and Thornhill, 2011, p. 151).

3.5 Data Collection

The data are the fundamental key of any decision–making process. The processing of

data gives statistics of importance of study (Panneerselvam, 2009, p. 14). The data

collection hepls in answer the research questions and meet the objectives (Saunders,

Lewis and Thornhill, 2011, p. 256). Thus data are classsified into two groups:

Primary data

The data which are gathered from the field under the control and guidance of an

examiner is considered as primary data. It a generally fresh data collected for the first

time. It mainly includes survey method, observation method, personal interview, mail

survey methods. In primary data collection the survey is conducted to determine the

market segment of particular product, or like to determine the moral of the employees

in the companies, all this examples are enclosed in primary data (Panneerselvam, 2009,

p. 17).

Secondary data

This data are collected from resources which are previously produced for the reason of

first time use and future use (Panneerselvam, 2009, p. 30). The secondary data includes

both raw data and published summaries. The involve both quantitative data and

qualitative data and used in both descriptive and explanatory research. Many

researchers (e.g. Bryman 1989; et al. 1988; Hakim 1982, 2000; Robson 2002) classified

seconday data into different catagories: documentary secondary data, multiple sources

data, and survey data (Saunders, Lewis and Thornhill, 2011, p. 258).

30

Data collection technique adopted in the present study

This study is primarily includes quantitative data therefore the research was performed

through collecting secondary data. The research is undertaken all the three sources of

secondary data. For this research documentary source data are used such as RBI

reports, Government reports, World Bank reports, journals. Multiple sources data

involve books, Government publications. And some government survey reports

(Saunders, Lewis and Thornhill, 2011, p. 259).

3.6 Statistical Tools

The present study has applied the regression model in examining the determinants and

the impacts of the FDI inflows in India. The determinants of FDI inflows in India has

been examined by the multiple regression technique is used while examining the impact

of FDI inflows on India the simple regression and Pearson’s coefficient is used.

Multiple Regression

This technique is widely applied by the scholars to examine the economic variables.

However, it is said to be a descriptive tool as it predict the value of dependable variable

by using independent variables in the multiple regression equation (Cooper and

Schindler, 2008, pp. 574-575). Thus, this technique is the best tool to find the

determinants and the impacts of FDI inflows in India. However, the following is the

general multiple regression equation:

Where

= a constant

= regression coefficient for each varaible

= error term

In the SPSS, there are three ways of constructing an equation i.e. Forward selection,

Backward selection and Stepwise selection. However, the first technique, first select the

variable that cause the largest R2 and similarly select other variables while Backward

selection technique, firstly exclude the variable that cause the least R2. But the Stepwise

selection is the best technique among them as it merges both the forward and backward

selection technique and select the most significant variable in the equation.

31

Furthermore, the regression model summary contains ‘β-value’ ‘R-values’ , ‘F-test’ and ‘t-

test’, they are the significant values of a regression model. As, the ‘β-value’ signifies how

much the independent variable impact the dependent variable (Gaur, A. S. and Guar, S. S.,

2009, p. 108). In addition, among the R-values, the adjusted R-square is the most

important as it signifies the accuracy of the model in predicting the value of the

dependent variable (Gaur, A. S. and Guar, S. S., 2009, p. 109), the F-test signifies that

whether the whole model is significant or not, while t-test signifies that whether an

individual variable is significant or not in the model (Makridakis, Wheelwright and

Hyndman, 2005, pp. 252-255).

Simple regression and Pearson’s correlation coefficient

In the present study, for determining the impact of FDI inflows, both the Simple

regression and Pearson’s correlation coefficient, methods are used, but there is a wide

difference between their approach. The Pearson’s coefficient of corellation signifies the

relationship between the two varaible i.e. negative correlation or positive correlation,

while regression coefficient signifies cause and effect of the variables (Gupta, 2007, p.

438). As the present study is investigating the relationship between the FDI inflows and

the other variables, the both the methods are a significant in the present study.

32

Chapter 4

Determinants and Impact of FDI in India

4.0 Introduction

Initially, this chapter describes the dependent and various explanatory variables i.e.

GDP, GDP growth rate, export, import, trade balance, openness, gross capital formation,

WPI, REER and interest rate, used in the research. Furthermore, the significant

determinants of FDI at macro level have been determined by using the stepwise linear

multiple regression model in SPSS. In addition, the impact of FDI in India have been

determined on various variables by employing Simple regression method. In nutshell,

this chapter comprises the various determinants of FDI and its Impact in India.

4.1 Variables and Data Collection

4.1.1 Data Collection

As the data collection is the critical part of any research, it is necessary to ensure that the

data should be accurate and reliable. As it was jotted by Nagaraj (2003) that there was

substantial quantity of ambiguity in the data of FDI flows in India, then it is necessary to

check the reliability of the data before studying the determinants and impacts of FDI in

India. The secondary data on FDI provided by the Reserve Bank of India, Department of

Industrial Policy and Promotion and Secretariat for Industrial Assistance are not

identical (See Appendix 6). As per the World Bank (2011) guidelines, Foreign direct

investment is the aggregate of equity capital, reinvestment of earnings, other long-term

capital and short term capital as exposed in the balance of payments. As the Government

of India had not maintained FDI data as per the international standards till 2001, the

data according to international standards is only provided by Department of Industrial

Policies and Promotion after 2001. In addition, the data on FDI inflows before 1991 has

not been maintained by any Indian Government department or agency. In such

circumstance, the data provided by the Indian Government agencies on the FDI inflows

is uncertain and inconsistent, in addition, it is not as pre the international standards.

Therefore, the data on the FDI inflows has gathered form the World Bank website to

maintain the certainity and consistency. Furthermore, the data related to Gross capital

formation and Domestic saving is also gathered from the ‘World Bank’ website, while

33

data on Import and Export is gathered form the ‘United Nations Conference on Trade

and Development’ website to maintain the international standards, consistency and

certainity. However, the data related to ‘Wholesale price index’ and ‘Real effective

exchange rate’ is gathered from the ‘Handbook of Statistics on the Indian Economy’,

annually published by the RBI.

Further, the explaination of expalanatory variables and how the data has converted into

the apposite form and made it suitable to accomplish the present study is discussed in

respective variables.

4.1.2 Explanatory Variables

Gross Domestic Product (GDP)

It is used as a proxy of market size of India. However, there are two variables which

represent the market size i.e. Gross National Product and Gross Domestic Product. Gross

National Product is defined as the sum of the ultimate value of the goods and services

produced in the county and net income from abroad within a specific preiod of time

(Mankiw, 2011, pp. 54-55). Whereas, Gross Domestic Product is defined as the final

value of the goods and servives produced in the country within a particular period of

time (Mankiw, 2011, pp. 54-55). Therefore, Gross Domestic Product can also be defined

as the Gross National Product minus net income from abroad (Mankiw, 2011, pp. 54-55).

However, as the research is conducted on the macrolevel determinants of FDI in host

country, it is appropriate to employ Gross Domestic Product as a proxy of market size of

India.

Furthermore, GDP can be calculated at market price as well as at constant price. If the

GDP is calculated at market price then it is called as GDP at market price. Otherwise if

calculated at base price of a year then it is called GDP at constant price. (Duffy, 1993, p.

34)

It has been well observed that in any given economy the price level never remains

constant, it keeps on vibrating and so to counterbalance the fluctations of the market,

the domestic product at current prices are converted into domestic product at constant

prices. When a country’s GDP esclates due to rise in its price then it cannot be

considered as a real rise in GDP. Real GDP takes into account constant base year- prices

to estimate the production of goods and services in an economy (Duffy, 1993, p. 35).

34

Real GDP is not influced by deviation in prices, swings in Real GDP suggetes some kind of

change in quantity of production (Mankiw, 2010, p. 205). For converting the current

GDP in real GDI, GDP deflator is used. However, a GDP deflator can be termed as a

‘conversion factor’ that alters real GDP into nominal GDP, the equation of conversion is

stated underneath (Duffy, 1993, p. 36).

The present study considers GDP for cumulative analysis, where the element constant

prices is one of the descriptive variables to understand the mechanism of FDI inflows in

Indian economy. The figures at constant prices are taken for the research to neglect the

consequences of inflation.

However, all the data is collected form World Bank website at current GDP and then by

using the GDP deflator of respective years, provided by the World bank website, the GDP

of the respective years at current price have been converted into real GDP.

At last, the advocates of market size hypothesis opinion that bigger financial markets

attract a bigger chunck of FDI inflows.

GDP Growth Rate (GDPg)

It has been observed over a period of time that a big size of a market doesn’t always

attract FDI inflows but many-a-times growth rate of a market does draw FDI inflows in

an economy. The growth rate of GDP can be defined as the percentage change in the the

curreny year’s GDP (Yc) to the previous year’s GDP (YL) (Mankiw, 2010), therefore GDP

growth rate can be stated as,

For the purpose of the study GDP Growth rate has been nominated as one of the

descriptive variable for the very reason that India is a growing economy and can tap a

lot of FDI. In addition, in present study GDP growth rate is calculated at constant price

by employing the above formula to calculated GDP at constant price (described above).

35

Export and Import

It has been established in the literature that the export and import are also the

significant determinant of the FDI inflows in a host country. Many scholars believe that

the many countries attract the FDI inflows for the export purposes, especially in

developing countries. The FDI inflows makes a portion of the capital account of the

Balance of Payment (BOP) and therfore it becomes dire necessary to include export and

import data based on BOP as a determinant at aggregate level. Therefore data supplied

on the basis of BOP has been gathered from the ‘United Nation Conference on Trade and

Development’ at current market price. However, the export deflator is neither provided

by the ‘World Bank’ nor by the ‘United Nation Conference on Trade and Development’,

the GDP deflator, provided by the ‘World Bank’ is used to convert Export at current price

into constant price.

Trade Balance

Trade Balance is the difference between exports free-on-board and imports free-on-

board (Duffy, 1993). A postive figure of trade balance reflects merchandise exports are

more than merchandise imports and when the figure is negative the situation is opposite

where imports exceeding exports. The study takes into consideration the data provided

on the basis of BOP and data is gathered from the ‘United Nations Conference of Trade

and Development’ website at current price. Similarly, as discussed earlier, the data is

converted into constant price by using GDP deflator. However, to ensure that the

converted data is correct or not, the difference between import and export at constant

price is used to tally with the converted trade figures.

Openness

Openness of an economy is also considered as a significant determinant of FDI inflows in

a host country. As Harrison (1996, cited in Mshomba, 2000, p. 39) revealed that “greater

openness is associated with greater growth”, and therefore openness forms one of the

determinants of FDI in India. However, different scholars define it in different ways, the

present study used the defination which is widely used in the studies; the extent of

openness of an economy is stated as the ratio of total trade to GDP of the economy

(Shaikh, 2010). As in the present study, all the figures have taken in real price, above

defination of ‘Openness’ can be formulated in the following way

36

Gross Capital Formation

Gross capital formation is defined as the sum of the domestic investment and the net

changes in the stock of inventory in an economy, it is formerly called as ‘Gross domestic

investment’ (World Bank, 2011). However, the World Bank has provided the percentage

of Gross capital formation to GDP, moreover, in the present study, the amount of real

Gross capital formation is required; to convert the percentage in the figure, the

calculated GDP at constant price is multiplied with percentage of the gross capital

formation to GDP.

Wholesale Price Index

Wholesale Price Index is an pointer which tells the changes in price level or a measure of

inflation (Shaikh, 2010, p. 305). The updated series of WPI is an economy-wide index

which includes 435commodities. For the present study, the WPI with 1993-94 base year

is used and the data is gathered form the ‘Handbook of Statistics on the Indian

Economy’, published by RBI in 2011. However, the values of WPI previous to the base

year are not provided at base year price, to convert the WPIs of the previous years, the

‘WPI of 1993-94’ valued at base year 1981-82 and the WPI at 1993-94 are used (the WPI

at base year 1993-94 equals to 100). Then the following relation is derived,

Real Effective Exchange Rate

The FDI inflows differ from one source country to other and so it becomes necessary to

have a proper weighted exchange rate index than bilateral exchange rates. The study for

the sake of reserach uses REER as an descripitive variable. The REER is a weighted

average of nominal effective interest rate (NEER) regulated by domestic to foreign

interest rates. The data related to real effective exchange rate is gathered from the

‘Handbook of Statistics on the Indian Economy’, published by RBI in 2011.

Interest rate

The literature reveal that the interest rate is also a significant determinant of FDI inflows

in a host country. In the present study, call money rate is used as a proxy of interest rate

37

in india, as it is the weighted arithmetic mean of the interest rate of major commercial

banks of India; moreover, all the major commercial banks report to RBI. Thus, in the

present study, the data is collected from the ‘Handbook of Statistics on the Indian

Economy’, published by RBI in 2011.

Domestic Saving/Gross Saving

Though, in the present study, domestic investment is not used as an Explanatory

variable of FDI inflows in India, but it is necessary to understand the relationship

between the FDI inflows and Domestic Investment in a host country. In the present

study, the data is collected from the World Bank website, like Gross capital formation,

the data on gross saving is also given in percentage to GDP. However, by applying the

similar processing, as applied in case of gross capital formation, the precentage of

domestic saving to GDP is converted into real domestic saving.

4.1.3 Dummy variables

Dummy variables is the essential variables of regression model as they categorize the

data into mutually exclusive groups (Gujarati and Sangeetha, 2007, p. 305). The ‘0’ and

‘1’ values are given to the absence and presence of an event respectively. However, in

the present study, two dummy variables are used, ‘D1’ repersents the post and pre

liberalization period of Indian economy ,thus ‘0’ is put in all the years before 1991 and

‘1’ is put in all the years from 1991; on the other hand, ‘D2’ is used for social-political

events occured in India during the period of study (See Appendix 5).

4.1.4 Dependent Variable

Foreign Direct investment

“Foreign direct investment are the net inflows of investment to acquire a lasting

management interest (10 percent or more of voting stock) in an enterprise operating in

an economy other than that of the investor”, World Bank (2011). As the present study is

conducted on the Foreign Direct Investment, the foreign direct investment is the

dependent variable on the explainatory variables. The data related to FDI is collected

from the World Bank website and converted into real price by using GDP deflator.

However, the following equation is the multiple linear regresion equation constructed to

to find out the significant determinants of FDI in India at macrolevel.

38

Where, ‘FDI’ is Foreing Direct Investment , ‘GDP’ is Gross Domestic Product , ‘GDPg’ is

GDP growth rate ‘GCF’ is the Gross Capital Formation, ‘IM’ is Import, ‘EX’ is Export, ‘TB’

is Trade Balance, ‘IR’ is Interest rate, ‘REER’ is Real Effective Exchange Rate, ‘WPI’ is

Wholesale Price Index , ‘OP’ is Openness to economy, ‘D1’ is dummy variable for

liberalization period of India Economy, ‘D2’ is dummy variabl for Social-Political events

occurred in India, ‘T’ is the Time Trend, ‘e’ in error term, and ‘t’ is time, here years.

However, by reviewing the literature in the chapter 2, the following null hypothesis are

constructed:

The GDP is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The GDPg is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The GCF is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The IM is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The EX is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The TB is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The IR is not a significant determinant of FDI inflows and its regression

coefficient is zero.

The REER is not a significant determinant of FDI inflows and its regression

coefficient is zero,

The WPI is not a significant determinant of FDI inflows and its regression

coefficient is zero.

39

The OP is not a significant determinant of FDI inflows and its regression

coefficient is zero.

4.2 Determinants of FDI inflows in India

4.2.1 Assortment of Significant Explanatory Variables

The selection of explanatory variable is a decisive process because there are various

variables provided by the previous theories and literature, out of them only the

combination of some of them is significant. However, to get a most excellent

amalgamation of variables which can significantly affect the FDI inflow in India, a

number of test on the combination of variables have been done. The study has adopted

the ‘linear multiple regression stepwise’ method to analyse the various independent

variables of FDI inflows in India. Futhermore, to get the appropriate determinants of FDI

in India, the regression process have done in two stages. Firstly, all the variables have

been included in the regression model in SPSS and then checked for their level of

significance in the model. Then, by employing the linear multiple regression stepwise

method in SPSS, a number of combination of models have produced on SPSS, the

unimportant variables have been excluded from the model and the significant variables

are selected by the SPSS automatically. Though, the models are produced by a program,

it is not necessary that the excluded variables are not significant in the model, it may be

that some of them are significant but at higher level of significance. However, following a

number of analysis of the distinct amalagamation of the explanatory variables, the study

has used the GDP, GFC, Import, Export, Interest Rate, Real Exchange Rate as explanatory

variables and a dummy variable to represent Social-political events and the following

equation is linear multiple regression is formed,

4.2.2 Assortment of Appropriate Functional Form of Regression

For the purpose of shunning the bigus results, selecting the appropriate functional form

of the regression equation is the next decisive process. However, in the present study

either linear or log-linear form of the regression equation will be abopted. The linear

and log-linear functional forms are as follow:

40

Where ‘L’ denotes the logarithmic value of the respective variables, whereas, α in the

coeffecient of the constant or also know as intercept and βs are the coefficients of the

respective variables. In order to select the appropriate functional form of the regression

equation, sargan’s method is used, as specified by Godfrey and Wickens (1981). As

defined by Godfrey and Wickens (1981), Sargan’s method can be formed as

Where,

RSS = Residual Sum of Squares of the Linear Regression equation

RSSL = Residual Sum of Squares of the Log-Linear Regresion equation

GMD = Geometric Mean of the Dependent Variable in Linear form, and

n = Number of observation

If the computed value of ‘S’ is larger than , then the log-linear form of the regression

equation will be accepted, otherwise, if the determined value is less than 1, then the

linear form of regression equation will be accepted (Godfrey and Wickens, 1981).

Then, by putting the values of RSS = 131999914.958, RSSL = 4.439, GMD = 759.6287 and

n = 30 in the above formula, the following result is appeared.

As, the resultant figure is greater than the 1, the Log-Linear regression equation is

adopted for the further study.

41

4.2.3 Findings of the Log-Linear Multiple Regression equation

As the main objective of this section is to ascertain the significant determinants of FDI

inflows in India at macrolevel, the following table is exposing them.

Table 4.1: Log-Linear Multiple Regression Model of LFDI

Explanatory Variables Unstandardized

Coefficients T Sig.

Constant 42.338 (7.778)*** .000

LGDP -1.595 (-1.611)* .122

LGCF 0.729 (0.633) .533

LIM 5.570 (3.468)*** .002

LEX -4.264 (-2.629)** .015

LIR -0.255 (-0.933) .361

LREER -7.270 (-6.756)*** .000

Social-Political (D2) -1.101 (-5.238)*** .000

R = 0.985

R Square = 0.970

Adjusted R Square = 0.960

F Statistics = 101.554***

Durbin-Watson Statistics = 2.141

Note:

*** Indicate that the coefficients are significant at 1% level

** Indicates that the coefficients are significant at 2% level

* Indicates that the coeffcients are significant at 15% level

The multiple regression model is constructed on SPSS by using Stepwise Regression Method

The table shows that the GDP, Gross Capital Formation, Import, Export, Interest Rate

and Real Effective Exchange Rate are the significant determinants of FDI inflows in India.

In additon, FDI inflows in India is also sensitive to the Social-Political factors that have

42

befallen in India. As the Durbin-Watson Statistics is slightly more than 2, which signifies

that model is free from the problem of autocorellation. In addition the model shows the

statistically fit as the value of adjucted R square is 0.96 which indicates that the

calculated values of the FDI by this model will be 96% correct. Furthermore, F statistics

is also too high i.e. 101.554, and significant at 1% significance level, which exhibits that

all the explanatory variable and dummy are significant in the model. However, the main

upper hand of the model is that the most variables are significant at 1% and 2%

significance level.

In addition, the model exhibits that the GDP, Export, Interest rate, Real Effective

Exchange Rate and social-Political factors deter the FDI inflows in India, whereas Gross

Domestic Investment and Import encourge the FDI inflows in India. However, it is clear

form the table that the import, Real Effective Exchahge Rate and Social Political factors

are the significant at 1% level, whereas export and GDP are significant at 2% and 15%

significane level respectively; while Gross Capital Formation and interest rate are not

more significant in the model.

As, the coefficient of regression of between FDI inflows and GDP is -1.595, which

demonstrates that a unit increase in the GDP cause 1.595 units decrease in the FDI

inflows in india, similarlly the coefficient of regression of Export, Interest rate, Real

Effective Exchange Rate and Social-Political factors express the same relationship with

the FDI inflows in India. while, regression coefficient between Import and FDI exhibits

that the 1 unit increase in the Import enhance the FDI inflows in the India, however

similar relationship exhibits between Gross Capital Formation and FDI inflows in India.

Furthermore, the validity of a model is the next most important objective of a study, in

order to verify the validity of the model and to check whether the determined

coefficents can provide some realistic results, a graphical representation is preferred

(see figure 4.1). A graph is developed with actual and calculated, by using the developed

regression equation, FDI inflows from 1981 to 2010 (see figure 4.1), the figure 4.1

clearly signifies that the actual and the calculated FDI inflows are moving together,

however, the calculated FDI inflows are more than the actual FDI inflows in India for

year 2007-08, this is only because of the global recession, as the study has not considerd

the dummy variable for global economic crises. Otherwise, the figure 4.1 clearly shows

43

that the model is valid and the determined coefficients are really making empirical

sense.

4.3 Impact of FDI in India

In the present study, to examine the impact of FDI on India, a simple regression model is

used. Thus, to establish the impact of FDI on other variables, the FDI becomes

independent variable and other variables become dependent variables. The regression

between FDI and other variables have been undertaken one by one. Furthermore, to

understand the relationship between the FDI inflows and variables, the Pearson’s

correlation coefficient is used.

4.3.1 Correlation Analysis

As most of the variables demonstrate some sort associations among them, correlation is

the one of the significant statistical tool to measure the relationship among them. The

realtionship is measured in one figure between two variables, the value of the

correlation signifies the degree of relationship between two variables (Gupta, 2007).

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1981

19

82

1983

19

84

1985

19

86

1987

19

88

1989

19

90

1991

19

92

1993

19

94

1995

19

96

1997

19

98

1999

20

00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

US

$ M

illio

n

Year

Figure 4.1: Actual and Calculated FDI Inflows 1981-2010

Calculated FDI inflows by Model Actual FDI inflows

44

However the correlation does not explain the cause and effect relationship among the

variables (Gupta, 2007) ( already discussed in methodology).

The below table reveals the Karl Pearson’s cofficient of correlation among variables. It

has established form the table that the foreign direct investment is highly positively

correlated to gross domestic production, gross capital formation, import, export,

wholesale price index and domestic investment and strongly negatively correlated to

interest rate and exchange rate at 1% of significance level.

However, gross domestic product is highly positively correlated to gross capital

formation, import, export, and domestic investment, while it is negatively correlation to

interest rate and real effective exchange rate. Furthermore, there is a sturdy positive

correlation between gross capital formation, and import, export and domestic saving.

However, interest rate and real effective exchange rate are positively correlated with

eachother, but negatively relative to other variables.

Table 4.2: Pearson’s Coefficient of Correlation

LFDI LGDP LGCF LIM LEX LWPI LIR LREE

R

LDS

LFDI 1

LGDP .738** 1

LGCF .797** .987** 1

LIM .867** .954** 0.978** 1

LEX .889** .939** .964** .995** 1

LWPI .937** .640** .707** .808** .849** 1

LIR -.582** -.452* -.496** -.561** -.560** -.592** 1

LREER -.836** -

.492** -.533** -.630** -.696** -.915** .367* 1

LDS .822** .983** .998** .983** .975** .738** -.516** -.573** 1

Note: ** Indicates that correlation is significant at 1% significance level (2-tailed)

* Indicates that the correlation is significant at 5% significance level (2-tailed)

The correlation is constructed on SPSS by using Bivariate Correlation

45

4.3.2 Simple Regression Analysis

Though, the correlation analysis examine the degree of relationship between FDI and

other variables, the simple regression will examine the impact of FDI on Indian

economy. However, the table 4.3, reveal that the FDI does impact the Gross domestic

product, Gross capital formation, Import, Export and Domestic saving. The coefficients

are clearly demonstrate that the FDI act as a catalyst in the Indian economy.

It is clear form the table 4.3 that a unit increase in the FDI inflow in india cause 0.201,

0.273, 0.367, 0.391 and 0.271 unit increase in the gross domestic product, gross capital

formation, import, export and domestic saving respectively at 1% significance level.

Thus, it is clear that the FDI has positive impact of the Indian economy. However, it is

necessary to compare the impact of FDI with the impact of gross capital formation on

the Indian economy, to examine whether the FDI is really a strong catalyst in the Indian

economy.

Table 4.3: Impact of Foreign Direct Investment on Selected Economic variables

Impacts of FDI Unstandardized

Coefficients t Sig.

FDI GDP .201 (5.792)*** .000

FDI GCF .273 (6.991)*** .000

FDI IM .367 (9.200)*** .000

FDI EX .391 (10.265)*** .000

FDI DS .276 (7.633)*** .000

Note:

*** Indicate that the coefficients are significant at 1% level

The simple regression is constructed on SPSS by using Linear Regression Method

46

Table 4.4: Impact of Gross Capital Formation on Selected Economic Variables

Impacts of GCF Unstandardized

Coefficients t Sig

GCF GDP .786 (32.864)*** .000

GCF FDI 2.329 (6.991)*** .000

GCF IM 1.211 (24.700)*** .000

GCF EX 1.241 (19.278)*** .000

GCF DS .978 (76.824)*** .000

Note:

*** Indicate that the coefficients are significant at 1% level

The simple regressionis constructed on SPSS by using Linear Regression Method

The simple regression analysis of gross domestic product, foreign direct investment,

import, export and domestic investment on gross capital formation in Table 4.3 reveals

that the 1 unit increase in the gross capital formation cause the 0.786, 2.329, 1.211,

1.241 and 0.978 units increase in the gross domestic product, foreign direct investment,

import, export and domestic investment on gross capital formation respectively.

However, by comparing the Table 4.3 and Table 4.3, it has been clear that the impacts of

the gross capital formation is quite higher than the impact of FDI on Indian economy.

At last this chapter established that the gross domestic product, import, export, real

effective exchange rate and the social-political events are the significant determinant of

the FDI inflows in the Indian economy by applying ‘Log-Linear Multiple Stepwise

Regression Model’. In addition, by employing the simple regression on FDI with other

variables individually, it has revealed that the FDI has significant impact on the gross

47

domestic product, gross capital formation, import, export and domestic saving.

However, gross capital formation has the more intensified impact on the macro

economic variables of the Indian economy. In the light of these recults the disussion is

carried out in the next chapter.

48

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

US

$ M

illio

n

Figure 4.2: Actual Flow of Foreign Direct Investment in India (Constant Price)

FDI Inflows Source: World Bank, 2011

0.00

200000.00

400000.00

600000.00

800000.00

1000000.00

1200000.00

1400000.00

1600000.00

1800000.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

US

$ M

illio

n

Years

Figure 4.3: Gross Domestic Product of India (Constant Price)

GDP Source: World Bank, 2011

49

0.00

100000.00

200000.00

300000.00

400000.00

500000.00

600000.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

US

$ M

illio

n

Figure 4.4: Gross Capital Formation of India (Constant Price)

Gross Capital Formation Source: World Bank, 2011

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

500000

1981

19

82

1983

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1995

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1997

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1999

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00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

US

$ M

illio

n

Years

Figure 4.5: Domestic Saving of India (Constant Price)

Domestic Saving Source: World Bank, 2011

50

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

40000.00

45000.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

US

$ M

illio

n

Figure 4.6: Import of India (Constant Price)

Import Source: World Bank, 2011

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

US

$ M

illio

n

Figure 4.7: Export of India (Constant Price)

Export Source: World Bank, 2011

51

0.00

5.00

10.00

15.00

20.00

25.00

1981

19

82

1983

19

84

1985

19

86

1987

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1989

19

90

1991

19

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1993

19

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1999

20

00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

Per

cen

t

Years

Figure 4.9: Interest Rates in India

Interest Rate Source: RBI, 2011

0.00

50.00

100.00

150.00

200.00

250.00

300.00

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

Ind

ex

Figure 4.8: Wholesale Price Index of India (Base Year 1993-94)

Wholesale Price Index Source: RBI, 2011

52

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

200.00

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

REE

R

Years

Figure 4.10: Real Effective Exchange Rate

Real Effective Exchange Rate Source: RBI, 2011

53

Chapter 5

Discussion of Results, Conclusion and Recommendations

5.0 Introduction

The main purpose of the present study has to ascertain the determinant of the FDI

inflows in India at macrolevel and its impacts on India with respective to various

variables. The present study has developed a multiple regression model to establish the

determinants of FDI in India and, simple regression model and Pearson’s coefficient of

correlation matrix to study the impact of FDI in India by analysing the relationship

between FDI and other variables. As, the previous chapter just exposed the finding of the

study, this chapter has discussed the finding of the persent study. This chapter also

related the findings to the literature where necessary. Futhermore, the conclusion is

provided followed by recommendations and limitations.

5.1 Discussion of Results

5.1.1 Determinants of FDI inflows in India at Macrolevel

The present study has failed to find the any association between FDI and GDP growth

rate, trade balance, wholesale price index, which is a proxy for inflation, openness.

However, the these variables are firmly supported by the literature of the FDI inflows in

a host country. As, Goldberg (1972), Tsai (1994) and, Nonnenberg and Mendonca (2004)

argued that the GDP growth rate is the significant determinant of FDI inflows in an

economy, the present has not found such relationship in India. In contrast, present study

supports the results of Reuber, et al. (1973) and Yang, Groenewold and Tcha (2000),

who were able to establish realtionship between FDI and GDP growth rate. In addition,

like Sahoo’s (2004) study on India, present study also tried to examine the trade balance

as a determinant of FDI inflows in India, but has not found to be an important

determinant, however, the identical result was found by the Sahoo (2004). Furthermore,

the persent study also used wholesale price index as proxy of inflation in India, but has

found that the inflation is insignificant determinant of FDI inflows in India, whereas

Gopinath (1998) and Sahoo (2004) in their study on India found that inflation had

negative impact on FDI. In addition, present study also found that openness of Indian

economy is not a significant determinant of FDI inflows in India, whereas Dritsaki, M.,

Dritsaki, C. and Adamopoulos (2004), Yang, Groenewold, and Tcha (2000) and

54

Chakrabarti (2001) argued that it has positive impact on FDI inflows, in contrast Sahoo

(2004) found a negative impact of openness of the Indian economy on the FDI inflows in

India. In support to this, the dummy variable also used for the pre and post liberalization

period of India economy, but has not found significant in the regression model. Thus, it

is simply displays that the Indian policies has not significantly attracted the FDI inflows.

Additionally, the Gross Capital Formation has not found to be significant determinant of

FDI inflows in India, but its presence in the model enhanced the accuracy of the model

to determine the FDI inflows. However, the similar results was found by Sahoo (2004) in

his study on India. In contrast, the literature provides the mixed views, some scholars

such as Ghazali (2010) established the positive relationship between the FDI inflows

and domestic investment in Pakistan.

However, the present study considered the GDP as a the proxy of the Market size and

assumed that it has a considerable positive affect on the FDI inflows in India. This

assumption is largely maintained by the market size hypothesis and various scholars

such as Scaperlanda and Mauer (1967), Bandare and White (1968), Tsai (1994) and,

Barrel and Pain (1996) who have studied the macrolevel determinants of FDI flows in a

host country. However, the present study found that Gross Domestic Product is a

significant variable in the regression model but it’s coefficient is negatively related to

FDI inflows in India, which signifies that the size of the Indian economy does not attract

the FDI inflows in the country, in contrast it defers the FDI inflows. This results is

supported by the results found by the Sahoo (2004) in his study on India. However, this

may be because, the magnitude of the FDI inflows in India is less than the magnitude of

the domestic investment. Additionally, because of consequences of the global economic

crisis, the FDI inflows has been declining in the country since 2007, but the gross

domestic product is excalating because of the intensified domestic investment during

the period, as shown in the figure 4.4, in the pervious chapter.

In addition, the import is found to be a significant determinant of FDI inflows in the

country, moreover it’s coefficient is positively realted to the FDI inflows which signifies

that the import of India attract the FDI inflows. However, this result was not expected, as

it was assumed that the import differs the FDI inflows in a country. This assumption is

also maintained in the literature of Kravis and Lipsey (1982) and Chen (1996), who

argued that the escalation of import in a country signifies that the cost of production is

55

rising in that country and dissuade the FDI inflows in that country. However, this

argument does not hold in case of India because the service sector of India attracts the

most FDI inflows (see appendix 3) in which transfers or import of technology from the

foreign firms is increasing (see appendix 3). In addition, it could be that the foreign firms

are investing in India but importing the assets from the home country.

Furthermore, the present study also found that the export is the significant variable in

the regression model to determine the FDI inflows, but it’s coefficient is negatively

related to the FDI inflows which signifies that the export deters the FDI inflows in the

country. However, in the study it was assumed that the export magnetized the FDI

inflows in a country as this notion is supported by the results of Jun and Singh (1996)

and Sahoo (2004). In contract, the present study support the findings of the Kumar,

(1990), who has found that export did not attract the FDI inflows in India. Albeit, this is

because the export has grown radically since 2007 whereas FDI inflows has declined as

already shown in the figure 4.7 and figure 4.2 respectively. In addition, the FDI inflows

in India are not export oriented, the foreign firm are more interested in capturing the

domestic market as India has the huge domestic market.

In the present study, the presence of the interest rate in the regression model intensified

the accuracy of the model, otherwise it has not found to be a significant determinant of

FDI inflows. However, it’s coefficient is negative which signifies that the high interest

rate deters the FDI inflows in the country. This result support the finding of Lucas

(1993) and Sahoo (2004), who argued that the interest rate is negatively related to FDI

inflows in a host country. In contrast, the present study contradict the findings of the

Gross and Trevino (1996), who argued that there is positive realtionship between the

interest rate and the FDI inflows in a host country. Anyhow, if the firms are raising the

capital from the India market, the high interest rate indicates high cost of capital for

firms; in addition, high interest rate deter the FDI inflows in a country if it considered to

be an opportunity cost, as higher the interest rate, higher the oppurtunity cost in a

country. However, it is noticable that since 2005 the interest rate in India is low, even

then there was a significant decline in the FDI inflows in the country, anyhow it could be

because of the global economic crisis.

The present study found that the exchange rate is the significant determinant in the

model and but deters the FDI inflows in India. It is clear from the model that the

56

exchange rate has the highest negative coeffcient in the model, which signifies that the

appreciation of the Rupee with respect to Dollar, deters the FDI inflows in India, in

addition, its impact on the FDI inflows is quite higher than the other variables. However,

most of the scholars tried to find the significance of the exchange rate in determining the

FDI inflows, but none of them able to provide a identical conclusion. While, the Rupee is

appreciating with respect to Dollar since 2007 and the FDI inflows are declining, which

signifies that the appreciation in the currency deter the FDI inflows in the counrtry.

5.1.2 Impact of FDI inflows in India at Macrolevel

The results of the impact of th FDI inflows in India reveal that the FDI inflows enhance

the economic variables of India, however its impacts are not prominent. However, the

present study support the literature of Bloningen and Wang (2004) and Kumar (2007)

who argued that the FDI inflows benefit the country.

The study found that the FDI enhanced the the GDP of India as the regression coefficient

is positive between them. However, the similar results were found by the Ghazali (2010)

and Iqbal, Shaikh and Shar (2010), who argued that the FDI inflows enhanced the GDP

of Pakistan. But the magnitude of its impact is less as compare to Gross Capital

Formation, because the amount of the gross capital formation is quite higher than

foreign direct investment in india. In addition, still there are many sectors who have not

yet attracted the significant amount of FDI and depend upon the domestic investment

for capital inflows. Moreover, it clear form the figure 4.2, 4.3 and 4.4 that even the FDI

inflows in India is declining, the GDP is rising, this is because of the intensified domestic

investment during the period, which keeps GDP escalating.

The present study also found that the a unit increase in the FDI cause .273 unit rise in

the gross capital formation, whereas, the a unit rise in the gross capital formation cause

2.329 units increase in the FDI inflows. This clearly shows that the FDI inflows enhance

the gross capital fomation, but the magnitude of the impact of gross capital formation is

quite higher than the FDI. However, this exibits that the foreign investors invest in India

when there is enhancement in the domestic investment, this could be because the

foreign investors consider the domestic investment a significant economic variable

which displays the economic prospect of the country.

57

Additionally, the results found that the FDI enhanced the import and export of India,

however, its impact on them is less as compare to the impact of gross capital formation.

This could be because of the depleted magnitude of the FDI as compare to the gross

capital formation. Moreover, it may be because of the less FDI in import and export

activities as comapre to the gross capital formation.

The impact of the FDI inflows on the domestic saving is also found to be positive,

however, similarly the impact of gross capital formation on domestic saving is higher

than the FDIs. This simply reveals that the contribution of the FDI in the enhancement of

the domestic saving is significant, but is less than the gross capital formation.

At last, FDI significantly enhanced the GDP, gross capital formation, import, export and

domestic saving, but its magnitude of impact is less as compare to the gross capital

formation. However, this is because of the magnitude of the domestic investment which

is quite higher than the FDI inflows in the Indian economy.

5.2 Conclusion

In the dynamic economic, where the economic variables changes their impacts daily, to

assume that only some economic variables determine the FDI inflows in a country is not

reliable and appropriate. As, the economic variables keep on changing, the determinants

of the FDI inflows are also change. This could be supported by the results of present

study, as the previous literature found various variable significant in determining the

FDI inflows, whereas the present study has found many of them insignificant. However,

this could be because of the geographical difference or difference in the policies of India

from other countries. Furthermore, the present study has not fully support the previous

studies conducted on India, this could be because of the changes in the economic

variable and the impact of the global economic crisis. However, the present study found

the significant determinant of FDI inflows in India at macrolevel i.e. gross capital

formation, import, export and real effective exchange rate. However, some economic

variables such GDP growth rate, gross capital formation, trade balance, openness,

interest rate etc., were assumed to be significant on the bases of literature, but they are

found to be insignificant in present study, which should be a concern for the policy

makers. In addition, the import found to be significant with positive regression

58

coefficient, while export found to be significant with negative regression coefficient,

which are not supported by the present literature. Therefore, the Indian poilcy makers

should pay attention to the these issues as the every country want to attract the FDI

inflows to enhance the export to balance the trade balance, but this is not happening in

India. Furthermore, the post and pre liberalization period, dummy variable, has not

found significant in the present model, while social-political events occured in India

found to have significant impact of the FDI inflows in India.

In addition, the present study also examined the impact of FDI inflows on some

economic variables i.e. gross domestic product, gross capital formation, import, export

and domestic saving and found to be significant impacts on them. However, the impact

of the gross capital formation in more significant on these variables including FDI

inflows than the impacts of FDI inflows because the magnitude of the gross capital

formation is quite higher than the FDI inflows in the country. Thus, it signifies that India

still has not significantly tasted the benefits of FDI inflows in a country.

At last, the present study found the significant determinants of FDI inflows in India and

constructed a regression model. In addition, the present study also successfully

examined the impact of FDI inflows in India. But, as discussed above, the economic

variables keep on changing, therefore the determinants and the impact of FDI inflows

keep on changing. Thus, in such conditions, it is difficult to provide a model that will

remain significant in long period for determining the FDI inflows, in addition, the

impacts of the FDI inflows also will not remain same.

5.3 Recommendations

The policymakers should promote the export oriented FDI inflows in the country by

reducing the tariff rates. Moreover, there should be no duty on the capital goods that are

imported for export purposes and the material that is imported for export purposes to

enhance the export oriented FDI inflows in manufacturing sector.

It has been noted that the magnitude of the impact of the FDI inflows in India was not

satisfactory. In this case the policymakers should provide the quick approvals to the

FDIs and should ensure that in further procees there should not be delays in

bureaucratic procedure.

59

5.4 Limitations of the Present Study

Like all other study, this present study is also conducted in the dynamic economy where

the economic variables do not remain the same. Thus, it difficult to ensure its long-term

validity of the present study.

60

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71

Appendices

Appendix 1: Statement of Originality and Authenticity

Appendix2: Research Ethics Clearance Forms

Appendix 3: Figure of FDI inflows in India

Appendix 4: Data used in the Present Study (at Current Price)

Appendix 5: Data used in the Present Study (at Constant price)

Appendix 6: Estimates of FDI inflows by RBI, DIPP ans SIA

Appendix 7: Some more theories of FDI flows

Appendix 8: The Dissertation Proposal

72

APPENDIX 1: Statement of Originality and Authenticity

FACULTY OF BUSINESS AND LAW

Postgraduate Scheme

Programme/course: M.Sc. Finance

Statement of Originality and Authenticity

This dissertation is an original and authentic piece of work by me. I have fully

acknowledged and referenced all material incorporated form secondary sources. It has

not, in whole or part, been presented elsewhere for assessment

I have read the Examination Regulations and I am aware of the potential consequences

of any breach of them.

Signature:

Name: Jitender Singh

Date: 21 October, 2011

73

Appendix 2: Research Ethics Clearance Form

Note: Yet, the Ethics form has not been received from the Leeds Metropolitian

University, but the form was dully signed by the Bhopal Supervisor. So, the ethic

form has not been provided.

74

Appendix 3: Figure of FDI inflows in India

42%

10% 7% 5%

4%

32%

Figure 1: Country-wise FDI flow 2000-2011

Mauritius

Singapore

U.S.A

United Kingdom

Netherland

Others

Source: DIPP, 2011

23%

58%

19%

Figure 2: Route-wise FDI inflow 1991-2011

Government Route (FIPB, SIA)

Automatic Route

Inflows through acquisition of existing shares

Source: SIA Newsletter, May 2011

75

21%

8%

8%

7% 7% 5%

5%

39%

Figure 3: Sector-wise Cumulative FDI inflow 2000-2011

Service Sector

Computer Software & Hardware

Telecommunications

Housing and Real Estate

Construction Activities

Automobile Industry

Power

Others

Source: DIPP, 2011

22%

14%

11% 11%

6%

36%

Figure 4: Foreign Technology Collobrations till December, 2009

U.S.A.

Germany

Japan

U.K.

Italy

Others

Source: DIIP, December, 2009

76

0

20

40

60

80

100

120

140

Nu

mb

er

of

Co

lla

bo

rati

on

s

Years

Figure 5: Foreign Technology Collaborations Approved

Foreign Technology Collaborations Approved

Source: DIPP, December,2009

0

5000

10000

15000

20000

25000

1991 1992 1993 1994 1996 1997 1998 1998 1999 2000

US

$ M

illio

ns

Years

Figure 8: Approved and Actual FDI inflows 1992-2000

Actual FDI inflows Approved FDI inflows

Source: DIPP,1998,

77

Appendix 4: Data used in the Present Study (at Current Price)

Years FDI GDP Gross Capital

Formation Domestic

Saving

1981 919.20 1904541.55 418999.14 399953.7259

1982 720.80 1976608.73 415087.83 395321.7463

1983 56.40 2151692.46 408821.57 387304.6422

1984 192.40 2096697.68 440306.51 440306.5121

1985 1060.90 2299405.80 528863.33 505869.2756

1986 1177.30 2463695.98 566650.08 542013.1161

1987 2123.20 2760037.95 607208.35 579607.9687

1988 912.50 2931499.75 703559.94 644929.9461

1989 2521.00 2929173.77 703001.71 644418.2303

1990 2366.90 3174666.16 761919.88 698426.5555

1991 735.38 2675235.05 588551.71 588551.7106

1992 2765.12 2455531.70 589327.61 564772.2912

1993 5503.70 2760373.66 579678.47 662489.6782

1994 9722.71 3235061.44 776414.74 776414.7446

1995 21436.28 3562989.91 962007.28 962007.2766

1996 24260.57 3883439.11 854356.60 893190.9949

1997 35773.30 4109151.67 986196.40 1027287.918

1998 26346.52 4162524.42 957380.62 957380.6173

1999 21685.91 4504761.99 1171238.12 1171238.118

2000 35842.17 4601820.32 1104436.88 1150455.079

2001 54719.47 4778488.59 1146837.26 1194622.148

2002 56260.40 5071899.54 1267974.89 1369412.877

2003 43227.48 5994613.90 1618545.75 1678491.891

2004 57712.97 7215732.49 2381191.72 2381191.721

2005 76064.25 8340358.01 2919125.30 2835721.723

2006 203359.47 9513399.59 3424823.85 3329689.856

2007 454826.52 12424262.53 4721219.76 4596977.137

2008 434062.77 12137825.70 4248238.99 4005482.48

2009 355958.62 13806408.44 4970307.04 4832242.953

2010 241591.81 17290102.42 5532832.77 4841228.678

78

Years Import Export Trade

Balance WPI Interest

Rate REER

GDP

Deflator (%)

1981 17434.00 11093.00 -6341.00 40.35 8.96 174.90 10.80 1982 17075.00 12291.00 -4784.00 42.33 8.78 168.72 8.10 1983 16641.00 12438.00 -4203.00 45.52 8.63 171.79 8.50

1984 17692.00 12683.00 -5009.00 48.47 9.95 169.20 7.90 1985 18557.00 12524.00 -6033.00 50.60 10.00 166.03 7.20 1986 18133.00 12627.00 -5506.00 53.55 9.99 153.00 6.80 1987 19970.00 14661.00 -5309.00 57.91 9.88 141.84 9.30 1988 22895.00 17025.00 -5870.00 62.23 9.77 136.39 8.20 1989 24779.00 20011.00 -4768.00 66.87 11.49 130.12 8.40 1990 27789.00 22594.00 -5189.00 73.73 15.85 127.16 10.70

1991 24757.00 22652.00 -2105.00 83.86 19.57 111.46 13.70 1992 28427.00 24562.00 -3866.00 92.29 14.42 107.04 9.00 1993 27462.00 26679.00 -783.00 100.00 6.99 100.00 9.80 1994 32895.00 31060.00 -1835.00 112.60 6.40 104.32 10.00 1995 42198.00 37405.00 -4793.00 121.60 17.73 98.19 9.10 1996 46078.00 40343.00 -5734.00 127.20 7.84 96.83 7.50 1997 50560.00 44119.00 -6441.00 132.80 8.69 100.77 6.50 1998 54081.00 45128.00 -8953.00 140.70 7.83 93.04 8.00

1999 60492.00 50176.00 -10316.00 145.30 8.87 95.99 3.80 2000 66589.00 59064.00 -7525.00 155.70 9.15 100.09 3.50 2001 66460.00 60698.00 -5762.00 161.30 7.16 100.86 3.00 2002 73035.00 69850.00 -3184.00 166.80 5.89 98.18 3.80 2003 91631.00 82865.00 -8766.00 175.90 4.62 99.56 3.60 2004 127434.00 114930.00 -12505.00 187.30 4.65 100.09 8.70 2005 178701.00 152147.00 -26554.00 195.50 5.60 102.35 4.20

2006 222892.00 191536.00 -31356.00 206.10 7.22 98.45 6.40 2007 281196.00 236916.00 -44280.00 215.90 6.07 104.81 5.80 2008 383384.00 298746.00 -84638.00 233.90 7.06 94.32 6.70 2009 317608.00 255519.00 -62089.00 242.70 3.24 92.43 7.50 2010 406327.00 333188.00 -73139.00 240.00 4.51 98.74 9.60

79

Appendix 5: Data used in the Present Study (at Constant price)

Years FDI Constant GDP Gross Capital

Formation Import Export

1981 99.27 205690.49 45251.91 1882.87 1198.04

1982 58.38 160105.31 33622.11 1383.08 995.57

1983 4.79 182893.86 34749.83 1414.49 1057.23

1984 15.20 165639.12 34784.21 1397.67 1001.96

1985 76.38 165557.22 38078.16 1336.10 901.73

1986 80.06 167531.33 38532.21 1233.04 858.64

1987 197.46 256683.53 56470.38 1857.21 1363.47

1988 74.83 240382.98 57691.92 1877.39 1396.05

1989 211.76 246050.60 59052.14 2081.44 1680.92

1990 253.26 339689.28 81525.43 2973.42 2417.56

1991 100.75 366507.20 80631.58 3391.71 3103.32

1992 248.86 220997.85 53039.48 2558.43 2210.58

1993 539.36 270516.62 56808.49 2691.28 2614.54

1994 972.27 323506.14 77641.47 3289.50 3106.00

1995 1950.70 324232.08 87542.66 3840.02 3403.86

1996 1819.54 291257.93 64076.75 3455.85 3025.73

1997 2325.26 267094.86 64102.77 3286.40 2867.74

1998 2107.72 333001.95 76590.45 4326.48 3610.24

1999 824.06 171180.96 44507.05 2298.70 1906.69

2000 1254.48 161063.71 38655.29 2330.62 2067.24

2001 1641.58 143354.66 34405.12 1993.80 1820.94

2002 2137.90 192732.18 48183.05 2775.33 2654.30

2003 1556.19 215806.10 58267.65 3298.72 2983.14

2004 5021.03 627768.73 207163.68 11086.76 9998.91

2005 3194.70 350295.04 122603.26 7505.44 6390.17

2006 13015.01 608857.57 219188.73 14265.09 12258.30

2007 26379.94 720607.23 273830.75 16309.37 13741.13

2008 29082.21 813234.32 284632.01 25686.73 20015.98

2009 26696.90 1035480.63 372773.03 23820.60 19163.93

2010 23192.81 1659849.83 531151.95 39007.39 31986.05

80

Years Trade

Balance Openness WPI Interest

Rate REER

Growth rate of

GDP Domestic

saving

Social political

Events

1981 -684.83 0.01 40.35 8.96 174.90 10.00 43195 0.00

1982 -387.50 0.01 42.33 8.78 168.72 -22.16 32021.06 0.00

1983 -357.26 0.01 45.52 8.63 171.79 14.23 32920.89 1.00

1984 -395.71 0.01 48.47 9.95 169.20 -9.43 34784.21 1.00

1985 -434.38 0.01 50.60 10.00 166.03 -0.05 36422.59 0.00

1986 -374.41 0.01 53.55 9.99 153.00 1.19 36856.89 0.00

1987 -493.74 0.01 57.91 9.88 141.84 53.22 53903.54 0.00

1988 -481.34 0.01 62.23 9.77 136.39 -6.35 52884.26 1.00

1989 -400.51 0.02 66.87 11.49 130.12 2.36 54131.13 0.00

1990 -555.22 0.02 73.73 15.85 127.16 38.06 74731.64 0.00

1991 -288.39 0.02 83.86 19.57 111.46 7.89 80631.58 1.00

1992 -347.94 0.02 92.29 14.42 107.04 -39.70 50829.51 1.00

1993 -76.73 0.02 100.00 6.99 100.00 22.41 64923.99 1.00

1994 -183.50 0.02 112.60 6.40 104.32 19.59 77641.47 0.00

1995 -436.16 0.02 121.60 17.73 98.19 0.22 87542.66 0.00

1996 -430.05 0.02 127.20 7.84 96.83 -10.17 66989.32 0.00

1997 -418.67 0.02 132.80 8.69 100.77 -8.30 66773.71 0.00

1998 -716.24 0.02 140.70 7.83 93.04 24.68 76590.45 1.00

1999 -392.01 0.02 145.30 8.87 95.99 -48.59 44507.05 1.00

2000 -263.38 0.03 155.70 9.15 100.09 -5.91 40265.93 1.00

2001 -172.86 0.03 161.30 7.16 100.86 -11.00 35838.66 0.00

2002 -120.99 0.03 166.80 5.89 98.18 34.44 52037.69 0.00

2003 -315.58 0.03 175.90 4.62 99.56 11.97 60425.71 0.00

2004 -1087.94 0.03 187.30 4.65 100.09 190.89 207163.7 0.00

2005 -1115.27 0.04 195.50 5.60 102.35 -44.20 119100.3 0.00

2006 -2006.78 0.04 206.10 7.22 98.45 73.81 213100.2 0.00

2007 -2568.24 0.04 215.90 6.07 104.81 18.35 266624.7 0.00

2008 -5670.75 0.06 233.90 7.06 94.32 12.85 268367.3 0.00

2009 -4656.68 0.04 242.70 3.24 92.43 27.33 362418.2 0.00

2010 -7021.34 0.04 240.00 4.51 98.74 60.30 464758 0.00

81

Appendix 6: Estimates of FDIinflows by RBI, DIPP ans SIA

Estimates of FDI from RBI, DIPP ans SIA (US $ Million)

Years RBI SIA DIIP

1991 129 144 -

1992 315 264 -

1993 586 607 -

1994 1314 992 -

1995 2144 2065 -

1996 2821 2545 -

1997 3557 3621 -

1998 2462 3359 -

1991 2155 2205 -

2000 4029 2428 4029

2001 6130 3571 6130

2002 5035 3361 5035

2003 4322 2079 4322

2004 6051 3213 6051

2005 8961 4355 8961

2006 22826 11119 22826

2007 34835 15921 34835

2008 35180 33029 37838

2009 37182 27044 37763

Source: RBI, 2010; DIIP, 2011 and SIA Newsletter, 2011

82

Appendix 7: Some more theories of FDI flows

The Product Life Cycle Hypothesis

Vernon developed this hypotheis in 1966 for elucidating the international investment

and international trade of U.S., but in 1979 he provided the detail explainantion to this

hypothesis. Vernon (1966, 1971) demonstrated that products undergo different stages

such as start, growth, maturity and decline, a arrangement that is match the process of

initiation, distribution, maturity and senescence. This hypothesis is significant as it

provides a new explaination to foreign investment, mainly for the manufacturing firms

which are highly indulge in research and development to innovate advance products

(Petrochilos, 1989).

Originally, product life cycle was divided into three stages. In first stage, to maintain an

efficient coordination between research and development department, and production

plants, a firm introduce the innovated product into its home market. Moreover, firm set

comparatively high price, as the innovated product has inelastic demand in home

country. In secong stage, when the product is matured, the firm export it to another

advance nations where income and demand are high. As the demand and compitition

increases, innovative frim indulge in FDI to manufacture product in that countries. At

last, the product is completely standardized and its production technique is no more in

the possession of innovated firm. Moreover, the firm faces increasing price competition

from the other firms, which eventually compel it to invest in developing countries for

low cost of production. The home country start importing the products from the foreign

countries and are net importer whereas the foreign countries become net exporters.

(Moosa, 2001, pp. 38-39)

Gruber, Mehta and Vernon (1967) found a strong relationship among the tendency of

innovating new products, performance of export, foreign investment, proportion of

locally manufactured products to export in one side and expenses of R&D on other side.

Moreover, Gruber Mehta and Vernon (1967) expalined the relationship between the

ratio of production of products to export and expense in R&D, as an indicator to

substitute the FDI for exporting in host country in the last stage of product cycle. Auty,

(1984) argued that it is chiefly aimed to elucidate the pattern of dispersal of innovated

products in developed countries specially from U. S. to other advance nations, but its

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pertinency has reduced as other developed nations reduced their economic gap with US.

However, Auty (1984) jotted that it is still applicable for capital intensive and scale

sensitive industries. Even, Vernon (1979) admitted that as the gap between U.S. and

other advance nations is narrowing, it will become complex to describe FDI through

product life cycle. In addition, Moosa (2001, p. 40) argued that this theory was

developed in 1960s, when U.S. was a leader in R&D and innovating new products; but,

now many advance nations are developing and introducing new products outside the U.

S., thus it is now complicated to expalin FDI by using the simple model of product life

cycle. To overcome the drawback of the hypothesis, other factors cost also taken into

account and it is relevant to explain FDI for all developed nations (Vernon, 1971).

Solomon (1978) argued that its applicability is only limited to those industries which are

highly innovative. Dollar (1987) argued that the product cycle hypothesis implicated

that the exit of any industry from advance nations is not a matter of anxiety as far as new

industries are growing due to innovations but in reality the relocation of manufacturing

industry in less developed countries for long period created unemployment in

developed countries.

However, the business environment has intensively changed since 1966, when this

hypothesis was firstly introduced and moreover, some of its assumptions do not sustain

today. Even, Vernon (1979) admitted that its ability to elucidate the reasons for

existence of FDI has declined.

Oligololistic Reaction Hypothesis

Knickerbocker (1973) by using the data from Harward School of Business

Administration on FDI by 187 American manufacturing MNCs, he build a entry

concentrated index (ECI) which demonstrated that American companies entered into

foreign countries in groups in time. It means in oligopolistic environment, if one firm

invest in foreign market, the other leading firms also start such investments in order to

sustain their market share. Knickerbocker (1973) established that the ECI and American

industrial concentration index were positively correlated and concluded that increase in

industrial concentration cause increase in oligopolistic reaction in FDI, but if the positive

correlation is very high then the structure of oligopolistic environment is stable and the

firms do not congest the host country. He also found that there was a positive

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correlation between profitability of FDI and entry concentration where as diversity of

product and entry concentration were negative correlated (Knickerbocker, 1973).

The successful test of this hypothesis was done by Flowers (1975, cited in, Moosa, 2001,

p. 42)) FDI flow in U.S. from Canada and Europe and found that concentration of FDI in

USA and the concentration of the Canada and European Countries are positive

correlated. But, Agarwal (1980) argued that the FDI in Germany and other nation had

increased from Japan, the global competition had increase in several sectors but still

there was no decline in total flow of FDI, which according to Kinckerbocker’s hypothesis

should happen; thus, its future predictability is limited.

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Name: Jitender Singh Student ID: c7102265 Course: MSC Finance Module: Dissertation Submission date: 7th April, 2011

Appendix 8: The Dissertation Proposal

86

Table of Content

S No. Page No.

1 Title of Research 3

2 Introduction 3

3 Research Questions and Objective 4-5

4 Preliminary literature review 5-7

5 Methodology 7-8

6 Significance of your study 8-9

7 Timescale 9

8 Resources 9

References

Appendix: Research Ethics Clearance Forms

87

Title of research

A study of the potential impact of Foreign Direct Investment on India with a focus on its

Infrastructure Sector.

Introduction to the Topic

Foreign direct investment (FDI) is an essential part of an open and effective

international economic system and a foremost means to development. As there is

shortage of capital in the developing countries, which need capital for their development

process, the marginal productivity of capital is higher in these countries. On the other

hand, investors in the developed world seek high returns for their capital. Hence there is

a mutual benefit in the international movement of capital.

Developing countries have come increasingly to see FDI as a source of economic

development and modernisation, income growth and employment. Countries have

liberalised their economies and ease FDI regimes and pursued other policies to attract

investment. The 1991 economic reforms in India with respect to FDI intended to achieve

economic growth. Foreign direct investment (FDI) has boomed in post-reform India.

Moreover, the composition and type of FDI has changed considerably since India has

opened up to world markets. This has fuelled high expectations that FDI may serve as a

catalyst to higher economic growth.

As India is one of the fastest growing economies, with a huge potential of growth in

Infrastructure. 100% FDI is allowed in infrastructure sector in India that means it can

affect the sector growth and the Indian economy dramatically. In the current scenario

FDI plays a vital role in the economic position of the emerging economies. The gap

between the world’s rich and poor countries largely comes down to the financial and

physical assets that create wealth. Developed economies have more money to invest

than developing countries, and they are more advance on technology. The implication is

clear: A key aspect of economic growth lies in poorer countries capacity to attain more

capital and scale the technological ladder. In India, infrastructure sector undertake some

capital formation on their own, but in this era of globalization, they increasingly rely on

foreign capital. The foreign capital has the potential to deliver enormous benefits to

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infrastructure sector in India. FDI has potential to boost technology, productivity,

investment and savings, which causes to infrastructure sector growth.

The overall research problem is the potential impact of the foreign direct investment

especially on infrastructure sector. There are lot of theories and empirical studies which

explains the positive and negative impacts of the FDI on the host country. Infrastructure

is the backbone of every economy; in country like India where there is lot of potential

growth of this sector, FDI investments in this sector play a vital role in the infrastructure

sector growth.

Research questions and objectives

Research questions:

Main question:

o What is the potential impact of FDI on India with a focus on

Infrastructure sector?

Sub questions:

o How can FDI effect the infrastructure sector growth and trade?

o What is the effect of FDI on saving and investment?

o What is the pattern of FDI in India?

- Origin(country) of Investment

- Entry mode.

o What is the environment of FDI in India, especially in infrastructure

sector?

- Government rules and regulations.

- Taxation policies.

- Central and state Government policies.

o Is FDI always good for infrastructure sector?

Research Objectives:

Main objective:

o To analyse the potential impact of FDI on India with a focus on

Infrastructure sector.

o To find the relationship between the FDI, infrastructure sector growth and

economic growth.

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Sub objectives:

o To find the relationship between FDI, saving and investment.

o To find the relationship between the:

- FDI and Trade.

- FDI and Origin of Investment.

- FDI and Entry Mode.

o To evaluate the environment of FDI in India, especially in infrastructure

sector.

- Government rules and regulations.

- Taxation policies.

- Central and state Government policies.

o To analysis the possible effects of FDI on India especially on Infrastructure

sector on the basis of historical events and investment patterns.

Review of Literature

Theoretical literature

The growing importance of FDI and growing interest in its cause and effect has

developed number of theories. Some theories try to emphasise on outward FDI and

others try to explain inward FDI. These theories of FDI are broadly classified as theories

assuming perfect market and theories assuming imperfect market. These theories

impacts are based on the positive and negative impact of FDI on the host economy.

There are three theories falls under perfect markets: (a) differential rate of return

(Htjfbauer, 1975), (b) portfolio diversification and (d) the output and market size.

Differential rate of return postulates that companies invest in the countries where rate

of return is high which move in a process that leads eventually to the equality of ex ante

real rate of return. The portfolio diversification theory is an improvement over the

differential rates of return theory in the sense that by including the risk factor, it can

account for countries experiencing simultaneously inflows and outflows of foreign direct

investment. A more fundamental criticism of this theory has been the argument that in a

perfect capital market there is no reason to have firms diversifying activities just to

reduce the risk for their stockholders. According to the market size hypothesis, the

amount of the FDI is depends upon the market size of the host country, which is

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measured by foreign company or by the host country’s GDP. The drawback of Market

size theory is it’s emphasise on inward FDI, that means, market size is likely to influence

the FDI undertaken to produce goods for host country consumption and FDI is not

aimed for export (Moosa, 2002, p.28)

The theories assuming imperfect competition are: (a) Industrial Organisation (Hymer,

1976), (b) Internalisation (Buckley and Casson, 1976), (c) Product Cycle (Vernon, 1966)

and (d) Oligopolistic Reaction (Knickerbocker, 1973). However, the element of all these

theories can be observed from Dunning's Eclectic Paradigm (Dunning 1977, 1979,

1988). The eclectic paradigm integrates three strands of literature on foreign direct

investment i.e. the industrial organization theory, the Internalisation theory and the

location theory. He argues that three conditions must be satisfied if a firm is to engage in

foreign direct investment. Firstly, the firm must have some ownership advantages with

respect to other firms and these advantages usually arise from the possession of firm-

specific intangible assets. Secondly, it must be more beneficial for the firm to use these

advantages rather than to sell or lease them to other independent firms. Finally, it must

be more profitable to use these advantages in combination with at least some factor

inputs located abroad; otherwise, foreign markets would be served exclusively by

exports. Thus, the foreign direct investment to take place, the firm must have ownership

and internalization advantages, and a foreign country must have location advantages

over the firm's home country.

Dunning further divided these advantages into three groups, viz., (i) Ownership

advantages, (ii) Location advantages and (iii) Internalisation advantages. All these three

advantages constitute the famous OLI (Ownership-Location-Internalisation) model of

Dunning. Though the OLI paradigm covers most of the determinants of the

FDI flows into a specific location; it doesn't cover certain firm specific variable like

labour productivity (LPR). The LPR is a very crucial guideline for investors to invest

especially at the sectoral level.

Empirical Literature

Frank Barry and John Bradley (1997) explored the structural changes induced by FDI

and the effects of FDI on the determinants of growth in Ireland. They also consider the

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possible adverse effects that may be associated with such strong reliance on

multinational investment. According to the study, Foreign - owned export-oriented firms

were investing in Ireland; the most striking consequence of FDI was that Irish economy

became totally dependent on the United Kingdom as a trading partner. But this study’s

findings do not hold on India because Ireland is demographically small country then

India; moreover, domestic demand in Ireland is small than India because India has huge

domestic market.

Lichtenberg and van Pottelsberghe (2001) modified the Coe and Helpman's framework,

to test whether FDI transfer technology in both, foreign and host country.

The empirical results showed that outward FDI flows and import flows are two

simultaneous channels through which technology spills over and benefits other

industrialized countries. The study found that the R&D base of the investing company is

strengthened whether it is Outward FDI or Inward FDI. The results suggest that inward

FDI, foreign companies are intended more to take advantage of the technology base of

the host countries than to diffuse the technological advantage originating in the home

country.

Prasad and et al (2007) studies the relationship between foreign capital and economic

growth. Their findings make clear that developing countries that are relied on foreign

capital have not grown faster than those that have not. According to them, these

countries relied on domestic rather than foreign saving to investment. Their study find

out that developing countries are building up foreign assets just to serve as collateral,

which can then draw in beneficial forms of foreign financing such as FDI. They find out

that developing countries have limited absorptive capacity for foreign resources. As

countries develop, absorptive capacity grows. But in case of India, after 1991 reforms,

the economic growth of country is much higher than other developing countries.

Moreover, in India the saving rate is high; even then country is relied on foreign capital.

Research Methodology

Research design

It is descripto-explanatory study as it is formalized study with clear stated

investigative questions and there are casual relationships between:

- FDI and Infrastructure Sector Growth

- FDI and Saving and Investment

92

- FDI and Trade.

- FDI and Origin of Investment

- FDI and Entry Mode.

In this research both quantitative and qualitative methods are used to analysis the data

therefore there is a mixed approach.

Quantitative methods are appropriate for objectives like

o To find the relationship between

- FDI, Infrastructure Sector Growth and economic growth.

- FDI, saving and investment.

- FDI and Trade.

- FDI and Origin of Investment.

- FDI and Entry Mode.

Qualitative methods are appropriate for objectives like

o To evaluate the environment of FDI in India, especially in infrastructure sector.

- Government rules and regulations.

- Taxation policies.

- Central and state Government policies.

In the research, secondary data will be used because only then this topic is feasible.

Data collection

In the research, secondary data will be collected, for analysing the data both

quantitative and qualitative methods used.

Secondary data will be collected by using written documentary material, multiple

source i.e. Government publications, books, journals, industry statistics and

industry reports.

Significance of your study

It is interesting and relevant to study FDI in the current scenario. FDI is quite important

for the countries starved of capital and also leads to higher returns for the surplus

capital from the developed countries. By doing research on this topic, we can analysis

the potential growth of infrastructure sector in India.

93

In this scenario of globalisation, FDI has a significant impact on infrastructure sector in

India. It is very important to understand the impact of FDI on growth, trade and

investment in infrastructure sector in India.

FDI offers attractive benefits that include technology, investments, savings and growth.

But emerging economies should exercise caution. Counter to economic intuition; FDI

may flow to riskier destinations.

Timescale:

I have decided to divide this dissertation into four major parts on the basis of objectives.

I start working on topic from first week of February.

Objectives (Task) Days

Impact of FDI on Infrastructure

sector

20-25 days

Effect of FDI on Saving and

Investment

20-25 days

Pattern of FDI in India

20-25 days

Environment of FDI in India

20-25 days

Is FDI always good for Infrastructure 20-25 days

And the remaining 20 days (approximately) for revision of research and i can use these

days as buffer.

Resources

I want suggestions from the tutor regarding the expert scholars who can provide me

their views. Also, I will try to have optimum utilisation of library and different search

engines.

94

Bibliography

Barry, Frank and Brodley, John (1997): “FDI and Trade Irish Host – Country Experience”,

The Economic Journal, Vol. 107, No. 445 pp.1798-1811

Buckley, P. J. and M. Casson (1976): The Future of the Multinational Enterprises, Macmillan: London.

Dunning, J. H. (1977): "Trade Location of Economic Activity and the MNE: A Search of an Eclectic Approach" in Ohlin, B., P. O. Hesselborn, and P. J.Wijkman (eds.): The International Allocation of Economic Activity. London: Macmillan.

Dunning, J. H. (1979): "Explaining Changing Patterns of International Production: In Defence of the Eclectic Theory;'' Oxford Bulletin of Economics and Statistics, Vol. 41, pp. 269 - 296.

Dunning, J. H. (1988): “The Eclectic Paradigm of International Production: A Restatement and Some Possible Extensions", Journal of International Business Studies, Vol. 19, pp. 1- 31.

Htjfbauer, G. C. (1975): "The Multinational Corporation and Direct Investment," International Trade and Finance: Frontiers for Research", in Peter B. K. (ed.), Cambridge University Press, Cambridge.

Hymer, S. H. (1976): The International Operation of National Firms: A Study of Direct Foreign Investment, MIT Press, Cambridge.

Knickerbocker, F. T (1973): Oligopolistic Reaction and Multinational Enterprise, Boston Division of Research, Harvard University Graduate School of Business Administration.

Moosa, Imad A. (2002): Foreign Direct Investment: Theory, Evidence and Practice. 2nd ed. New York: PALGRAVE

Porterie, Bruno van Pottelsberghe le la and Lichlenberg, Frank (2001): “Does Foreign Direct Investment Transfer technology Across Borders?” The review of economics and statistics, Vol. 83, No.3, pp. 490-479

Prasad, Eswar S., Ranjan, Raghuram G. And Subramanian, Arvind (2007): “Foreign Capital and Economic Growth” Brooking Paper on Economic Activity, Vol. 2007, No. 1, pp. 153-209

Vernon, R. (1966): "International Investment and International Trade in the Product

Cycle", Quarterly Journal of Economics, Vol. 80, pp. 190-207.