Understanding the Determinants and Impacts of FDI Inflows - An Indian Perspective

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.

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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.

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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

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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

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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

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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

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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

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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.

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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.

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 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.

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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

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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.

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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.

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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.

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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

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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).

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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
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
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
 The GCF is not a significant determinant of FDI inflows and its regression
 The IM is not a significant determinant of FDI inflows and its regression
 The EX is not a significant determinant of FDI inflows and its regression
 The TB is not a significant determinant of FDI inflows and its regression
 The IR is not a significant determinant of FDI inflows and its regression
 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

39
 The OP is not a significant determinant of FDI inflows and its regression
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.

Understanding the Determinants and Impacts of FDI Inflows - An Indian Perspective

Understanding the Determinants and Impacts of FDI Inflows - An Indian Perspective

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