Foreign Direct Investment (FDI) also known as non-debt financial capital, is considered to be the most preferred mode of capital flow for an economy. This implies that FDI can have a positive effect on the host economy’s development efforts. Here we present the impacts of FDI on Indian economy. Generally, FDI plays a substantial role in spreading general capital formation in the Indian Economy.
Foreign Direct Investment (FDI) generates returns in production through positive externalities towards stable economic growth. Although, it is relevant to most developing countries. India is mainly tested as the most attractive and common destination for foreign Direct Investment. FDI in India has reached 17800 USD million by August 2020. There are the exact factors that determine the FDI.
It has been argued on this line that FDI can bring about technological dissemination in areas through the dissemination of knowledge and accelerates the rate of growth of production through an increase in labor productivity in India.
There were also some pieces of evidence that show that there is a long-lasting relationship between Gross Domestic Product (GDP), FDI, and export in India. In fact, many countries such as India have provided incentives to stimulus FDI to their economies. India has opened up its economy and permitted MNEs in key sectors like Power and fuel, Transport, Food processing, Electrical Equipment, Chemicals, textiles, and industrial machinery as a part of the procedure that began in the early 1990s.
Dimensions of FDI in India
The dimensions of the FDI flows into India can be defined in terms of its growth and size, sources, and sectoral compositions. The growth of FDI inflows in India was not significant until 1991 because of the regulatory policy structure. Although, under the new policy management, it is expected to play a much larger role in catalyzing Indian economic growth. It can be seen that three has been a constant increase in the actual FDI inflows in the post-liberalization tenure. The actual inflows have been increasing regularly from Rs. 3,514.30 million in 1991 to Rs. 143,009.40 million in 2003. This results in an annual average growth rate close to 6 percent.
FDI and Economic Growth
The historical background of FDI in India can be traced back to the establishment of the East India Company of Britain. British capital came to India during the colonial era of Britain in India. After the second world war, Japanese companies entered the Indian market and increased their trade with India, yet the UK remained the most dominant investor in India. Further, after Independence issues relating to foreign capital, operations of MNCs gained the attention of the policymakers. Keeping in mind the national interests the policymakers designed the FDI policy which aims at FDI as a medium for acquiring advanced technology and to mobilize foreign exchange resources. With time and according to the economic and political regimes there have been changes in the FDI policy too. The industrial policy of 1965, permitted MNCs to venture through technical collaboration in India. Hence, the government adopted a liberal attitude by permitting more frequent equity.
FDI and the Host Economy
The Studies on FDI and economic growth in India are very limited. A current study by Banga shows that FDI, trade, and technological progress have different effects on wages and employment. While a higher extent of FDI in an industry leads to a higher wage rate in the industry, it has no effect on its employment. On the other hand, the higher export intensity of an industry increases employment in the industry but has no impact on its wage rate. Technological progress has been found to be labor-saving but does not affect the wage rate. Further, the results show that domestic innovation has been labor-intensive in nature in terms of research and development intensity but the import of technology has adversely affected employment in India.
The study by Dua and Rashid for the Indian economy doesn’t support the unidirectional causality from FDI to the index of Industrial Production (IIP), where IIP is taken as the proxy for GDP. In fact, this study used the monthly data for IIP and GDP, which may involve seasonal components in its variation, and therefore it is needed to de-seasonable the data. Alam in his comparative study of FDI and economic growth for Indian and Bangladesh economy stressed that though the impact of FDI on Indian economy is high, it is still not satisfactory.
The study reveals that GDP in India is not Granger caused by FDI; the causality runs more from GDP to FDI and the trade liberalization policy of the Indian government had a few positive short-run effects on the FDI flow. The study by Sahoo and Mathiyazhagan also supports the perspective that FDI in India is unable to increase the growth of the economy. Though there is a common consensus among all the studies in the Indian context that FDI is not a growth energizer rather it is a growth resultant, none of the studies have tried to examine the role of FDI at the sectoral level in the Indian economy. The present study is an endeavor in this regard.
It is also imperative to note that there is rarely any study that analyzes the impact of FDI at the sectoral level. Since FDI is the key factor in liberalization and globalization policy of all the transitional economies involving in India, the present study is an endeavor since it examines the impact of FDI at the sectoral level, by using the precise new technique call Panel Co-integration to validate the results of the analysis.