FDI in India and its Determinants Group V , FMS PT
FDI∗ Foreign direct investment (FDI) is direct investment into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.
FDI Advantages Disadvantages∗ Inflow of equipment and ∗ Crowding of local industry technology ∗ Loss of control∗ Competitive advantage and ∗ Conflicts of codes/laws innovation ∗ Possible exploitation of∗ Financial resources for resources material/wages expansion ∗ Effect on natural environment∗ Employment generation ∗ Effect on local culture∗ Contribution to exports growth∗ Access to new market/distribution channel for products
Hypothesis∗ FDI is a function of the factors specific to a country such as∗ Income, Exchange rate,∗ Technology, Human capital and∗ Openness in the economy with specific reference to Indian economy.
Methodology FDI=F(Y,I,ER,T,HC,O,D) + – + + + + + + + - + + + +Where FDI = Outward/inward flows of FDIY = Real GDPI = Interest rateER = Real Effective Exchange Rate (REER) IndexT = Technology variable.HC = Human capital variable, approximated by number of education students.O = Openness of the economy, Net ExportsD = Dummy variable for measuring the impact of liberalization process started in 1991 in the Indian economy. It takes the value 0 for the years between 1980 and 1991 and the value 1 for the years between 1991 and 2005.
Income/Real GDPGDP of the economy.∗ It is generally observed that the pattern of International Trade in terms of the composition and direction changes with development of an economy.∗ There are changes observed in the internal sectors also such as increasing share of industry and service sectors, the capital intensity of production increases, demand patterns move towards the consumption of differentiated products and markets grow.∗ The latter improves the realization of economies of scale through specialization, the introduction of new technology and greater volumes of output
GDP and FDI Source: http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Statistics%20on%20Indian %20Economy Foreign Investment (000 USD GDP(00000 CroreYear Millions) INR) 1998-99 2.401 17.865251999-2000 5.181 19.250172000-01 6.789 20.977262001-02 8.151 22.614152002-03 6.014 25.381712003-04 15.699 28.777062004-05 15.366 23.820682005-06 21.453 27.469282006-07 29.082 43.036542007-08 34.36 50.234 Foreign investment shows a strong correlation (polynomial) with GDP in the last decade(1998-2008).
Exchange rate∗ The appreciation and depreciation of currency does have an impact on the price of exports and imports making their comparative position and competitiveness in international markets fluctuate sometimes towards advantage to the home country and sometimes disadvantage.
FDI and Exchange rate Source:http://www.rbi.org.in/scripts/AnnualPublications.aspx? Month- Currency in FDI (00 USD year(2008) INR Million) Sep 45.5635 25.62 oct 48.6555 14.97 nov 48.9994 10.83 dec 48.6345 13.62 jan 48.8338 27.33 feb 49.2611 14.88 mar 51.2287 19.56 apr 50.0619 23.39 may 48.533 20.95 june 47.7714 25.82 july 48.4783 35.16 aug 48.5348 32.68 sep 49.4697 15.12A trend analysis of the FDI inflows to India and the exchange rates prevailing inthe financial year 2008-09 shows a trend which doesn’t depict a very strongCorrelation between the two chosen parameters.
Interest rate∗ Foreign operations require significant commitment in capital, especially if they are undertaken in capital intensive sectors where production is characterized by extensive economies of scale, as the case is for most FDI.∗ If there is abundant capital in the home country, that may become one of the primary reasons for going in for foreign investment by large firms. Such firms would have adequate financial means and they would also be able to access the capital markets much more efficiently than small capital starved firms. The opportunity cost of capital for such firms also comes down due to relatively low interest rate which occurs as a result of capital abundance.
Technology∗ This factor is widely recognized as one factor that does have a sure and great impact on FDI, in fact the FDI sometimes may be the cause for increasing technological progress as it also gets influenced by the level of technological progress of the economy∗ The ability of firms to generate technological inputs of a country is approximated by the number of patents issued. Thus higher the patents issued higher would be the outward FDI propensity of the country
Human Capital∗ The availability of the human resources is one factor that plays an important role in determining the FDI; however the sheer number does not affect the inflow as the quality of the human resource does.∗ The size of labour force may be instrumental in determining the price of the factor, as low labour cost may increase the cost competitiveness of the firm.∗ But in a skill intensive industry, the quality of the labour force determined by the number of people who are educated and the number of science and technology professionals that exist matters. The human capital supply varies depends largely on the education systems and also the government policies.
The Openness of the Economy∗ The FDI activities of the firms are constrained when there is protectionist policy followed; therefore these activities are encouraged when the country embarks on the path of liberalization.
Conclusion∗ Growth of the economy: The growth rate of the home economy is an important determinant of FDI into the country.∗ Size of the economy: The FDI flows also depend on the size of the home economy.∗ Real exchange rate: Any depreciation in the currency of India will make our country more favorable for foreign investments.∗ Degree of openness of the economy :Any FDI investment into a country depends upon how ‘open’ the economy is towards foreign trade (both imports and exports). We have captured the ‘openness’ of the economy through the proxy variable, DO (Degree of Openness) where it is given by DO = (Imports+Exports)/GDP