INTRODUCTION

Foreign Capital is the source,amount or amount of goods that is introduced in a

host country by a foreign country.
Getting resources from another country or from outside the boundry of our
country.
When people think about globalization, they often first think of the increasing
volume of trade in goods and services. Trade flows are indeed one of the most
visible aspects of globalization. But many analysts argue that international
investment is a much more powerful force in propelling the world toward closer
economic integration. Investment, often alter sentire methods of production
through transfers of know-how, technology and management techniques, and
thereby initiates much more significant change than the simple trading of goods.
Over the past ten years, foreign investment has grown at a significantly more
rapid pace than either international trade or world economic production generally.
From 1980 to1998, international capital flows, a key indication of investment
across borders, grew by almost 25% annually, compared to the 5% growth rate of
international trade. This investment has been a powerful catalyst for economic
growth. But as with many of the other aspects of globalization, foreign investment
is raising many new questions about economic, cultural and political relationships
around the world. Flows of investment and the rules that govern or fail to govern
it can have profound impacts upon such diverse issues as economic development,
environmental protection, labor standards and economic stability. Forms of
Foreign Investment International investment or capital flows fall into four
principal
There are many Forms of Foreign Capital Flowing into India such as banking
and NRI deposits. The various Forms of Foreign Capital Flowing into India has
helped to bring in huge amounts of FDI into the country, which in its turn has
given a major boost to the Indian economy.

Foreign Direct Investment (FDI):

This category refers to international investment in which the investor obtains a

lasting interest in an enterprise in another country. FDI is calculated to include all
kinds of capital contributions, such as the purchases of stocks, as well as the
reinvestment of earnings by a wholly owned company incorporated abroad
(subsidiary), and the lending of funds to a foreign subsidiary or branch. The
reinvestment of earnings and transfer of assets between a parent company and its
subsidiary often constitutes a significant part of FDI calculations. An investor's
earnings on FDI take the form of profits such as dividends, retained earnings,
management fees and royalty payments. International investment or capital flows
fall into four principal categories: commercial loans, official flows, foreign direct
investment (FDI), and foreign portfolio investment (FPI).Commercial loans,
which primarily take the form of bank loans issued to foreign businesses or
governments.Official flows, which refer generally to the forms of development
assistance that developed nations give to developing ones.
Foreign direct investment (FDI) pertains to international investment in which the
investor obtains a lasting interest in an enterprise in another country. Most
concretely, it may take the form of buying or constructing a factory in a foreign
country or adding improvements to such a facility, in the form of property, plants,
or equipment.
FDI is calculated to include all kinds of capital contributions, such as the
purchases of stocks, as well as the reinvestment of earnings by a wholly owned
company incorporated abroad (subsidiary), and the lending of funds to a foreign
subsidiary or branch. The reinvestment of earnings and transfer of assets between
a parent company and its subsidiary often constitutes a significant part of FDI
calculations.According to the United Nations Conference on Trade and
Development (UNCTAD), the global expansion of FDI is currently being driven
by over 65,000 transnational corporations with more than 850,000 foreign
affiliates.An investors earnings on FDI take the form of profits such as
dividends, retained earnings, management fees and royalty payments.

Foreign Portfolio/ Institutional Investment (FII):

FII is a category of investment instruments that are more easily traded, may be
less permanent, and do not represent a controlling stake in an enterprise. These
include investments via equity instruments (stocks) or debt (bonds) of a foreign
enterprise which does not necessarily represent a long-term interest. The returns
that an investor acquires on FII usually take the form of interest payments or nonvoting dividends. Investments in FII that are made for less than one year are
distinguished as short-term portfolio flows. Foreign portfolio investment (FPI), on
the otherhand is a category of investment instruments that is more easily traded,
may be less permanent, and do not represent a controlling stake in an enterprise.
These include investments via equity instruments (stocks) or debt (bonds) of a
foreign enterprise which does not necessarily represent a long-term interest.
Stocks:

dividend payments

holder owns a part of a company

possible voting rights

open-ended holding period

Bonds:

interest payments

ownership of bond rights only

no voting rights

specific holding period

While FDI tends to be commonly undertaken by multinational corporations, FPI

comes from my diverse sources such as a small companys pension or through
mutual funds held by individuals.
The returns that an investor acquires on FPI usually take the form of interest
payments or dividends.

Investments in FPI that are made for less than one year are distinguished as shortterm portfolio flows. FPI flows tend to be more difficult to calculate definitively,
because they comprise so many different instruments, and also because reporting
is often poor. Estimates on FPI totals generally vary from levels equaling half of
FDI totals, to roughly one-third more than FDI totals.

DIFFERENCES BETWEEN PORTFOLIO AND DIRECT

INVESTMENT
One of the most important distinctions between portfolio and direct investment to
have emerged from this young era of globalization is that portfolio investment can
be much more volatile. Changes in the investment conditions in a country or
region can lead to dramatic swings in portfolio investment. For a country on the
rise, FPI can bring about rapid development, helping an emerging economy move
quickly to take advantage of economic opportunity, creating many new jobs and
significant wealth. However, when a countrys economic situation takes a down
turn sometimes just by failing to meet the expectations of international investors
the large flow of money into a country can turn into a stampede away from it.
By contrast, because FDI implies a controlling stake in a business, and often
connotes ownership of physical assets such as equipment, buildings and real
estate, FDI is more difficult to pull out or sell off. Consequently, direct investors
may be more committed to managing their international investments, and less
likely to pull out at the first sign of trouble.
This volatility has effects beyond the specific industries in which foreign
investments have been made. Because capital flows can also affect the exchange
rate of a nations currency, a quick withdrawal of investment can lead to rapid
decline in the purchasing power of a currency. Such quick withdrawals can
produce widespread economic crises.
This was partly the case in the Asian economic crisis that began in 1997.
Although the economic turmoil began as a result of some broader shifts in
international economic policy and some serious problems within the banking and
financial sectors of the affected East Asian nations, the capital flight that ensued
some compared it to the great financial panics which took place in the United
States during the 19th century significantly exacerbated the crisis.

WHY DO COMPANIES INVEST OVERSEAS?

Companies choose to invest in foreign markets for a number of reasons, often the
same reasons for expanding their operations within their home country. The
economist John Dunning has identified four primary reasons for corporate foreign
investments (Global Capitalism, FDI and Competitiveness, 2002):
Market seeking: Firms may go overseas to find new buyers for their goods and
services. The top executives or owners of a company may realize that their
product is unique or superior to the competition in foreign markets and seek to
take advantage of this opportunity. Another motivation for market-seeking occurs
when producers have saturated sales in their home market, or when they believe
investments overseas will bring higher returns than additional investments at
home. This is often the case with high technology goods. As one analyst noted,
The minimum size of market needed to support technological development in
certain industries is now larger than the largest national market (Sutherland
1998).
Resource seeking: Put simply, a company may find it cheaper to produce its
product in a foreign subsidiary- for the purpose of selling it either at home or in
foreign markets. The foreign facility may be able to obtain superior or less costly
access to the inputs of production (land, labor, capital, and natural resources) than
at home.
Strategic asset seeking: Firms may seek to invest in other companies abroad to
help build strategic assets, such as distribution networks or new technology. This
may involve the establishment of partnerships with other existing foreign firms
that specialize in certain aspects of production.
Efficiency seeking: Multinational companies may also seek to reorganize their
overseas holdings in response to broader economic changes. For example, the
creation of a new free trade agreement among a group of countries may suddenly
make a facility located in one of those countries more competitive, because of
access for the facility to lower tariff rates within the group. Fluctuations in
exchange rates may also change the profit calculations of a firm, leading the firm
to shift the allocation of its resources.

The role of foreign capital in economic growth is much discussed nowadays but
remarkably little analysed. The basic objective of this chapter is to investigate the
causal long run relationship between FCIs and economic growth of India. The
FCIs-growth linkage assumes that the foreign capital inflows provide a significant
amount of contribution to the economic growth. To examine the same, first the
researcher developed a model on the basis of source of financing available to an
economy i.e. domestic capital and foreign capital. After that the researcher
employed co-integration test and Error Correction Model (ECM) technique.
The recent wave of financial globalization and its aftermath has been marked by a
surge in international capital flows among the industrial and developing countries,
where the notions of tense capital flows have been associated with high growth
rates (Edwin, 1950) in some developing countries. Some countries have
experienced periodic collapse in growth rates and financial crisis over the same
period. There is an ongoing debate on the pros and cons of Capital inflows i.e. is
there any strong positive connection between foreign capital inflows (FCIs) and
growth? Evidence on this very important question is far from ambiguous, with
China lending support and Brazil negating it. Since 1994, Brazil has attracted
enormous FDI from the developed countries, but neither the growth rate nor the
export prospects have showed Commen surate results. The study by Carkovic and
Levin (2002) failed to find strong evidence of positive correlation between FDI
inflows and output growth. The comments made earlier about the feasibility of
economic development without dependence on foreign borrowing are relevant
too. Historically, all of the three countries- Japan, South Korea and Taiwan very
carefully regulated foreign investment inflow during their period of growth
(Griffin, 2009). Theoretical and empirical research on the role of foreign capital
in the growth process has generally yielded conflicting results (Waheed, 2004).

Conventionally, the two-gap approach justifies the role of foreign capital for
relaxing the two major constraints to growth (Chenery and

Burno, 1962;

Mckinnon, 1964). In the neoclassical framework, however, capital

neither

explains differences in the levels and rates of growth across countries nor can
large capital flows make any significant difference to the growth rate that a
country could achieve (Krugman, 1993). Fitz Gerald (1998) theoretically argues
that higher capital inflows lower interest rates, which help increase investment
and economic growth. In their attempt to measure the link between growth and
capital inflows into India, Marwah and Klein (1998) starts by discussing the two
alternative frameworks for analysing the impact of inflows:

a macroeconomic growth model in which the 62 effect of FDI is

examined through its effects on the saving ratio and the capital output

ratio and
a multifactor production function is estimated to capture the changes

induced by FDI in the relevant parameters. Adopting framework

they assume constant returns to scale and four main inputs- labour,
domestic capital, foreign capital and imports.

The econometric analysis is based on annual observations for the period 1951-89
or appropriate sub periods. Results suggest that for every one percentage growth
point, 0.351 is generated by growth of domestic and foreign capital

nested

together, 0.569 by labour and 0.08 by imports. The contribution of the two types
of capital to the growth in productivity can be allocated in proportion to their
respective weights in the total nest. In this chapter an attempt has been made to
establish the relationship between foreign capital and economic growth of the
Indian economy. The purpose of foreign capital to under developed countries is
to accelerate their economic development upto a point

where a satisfactory

growth rate can be achieved on a self-sustaining basis. Capital flows in the form
of private investment; foreign investment, foreign aid and private bank lending
are the principal ways by which resources can come from rich to poor
countries. The transmission of technology, ideas and knowledge are other special
types of resource transfers. Capital flows have begun to play a significant role in
Indias growth dynamics.

Factors Influencing Foreign Investment Decisions

The policy frameworks relating to FDI and FII are relatively similar, although
there are a few differences. The determinants of FII are somewhat complex
because portfolio investment earnings are more likely to be tied to the broader
macroeconomic indicators of a country, such as overall market capitalization of an
economy, they can be more sensitive to factors such as: High national economic
growth rates Exchange rate stability General macroeconomic stability
Levels of foreign exchange reserves held by the central bank General health of
the foreign banking system Liquidity of the stock and bond market Interest
rates In addition to these general economic indicators, portfolio investors also
look at the economic policy environment as well, and especially at factors such
as: The ease of repatriating dividends and capital Taxes on capital gains
Regulation of the stock and bond markets The quality of domestic accounting and
disclosure systems The speed and reliability of dispute settlement systems The
degree of protection of investor's rights Now that you understand the basic
economic reasons why companies choose to invest in foreign markets, and what
forms that investment may take, it is important to understand the other factors that
influence where and why companies decide to invest overseas. These other factors
relate not only to the overall economic outlook for a country, but also to economic
policy decisions taken by foreign governmentsaspects that can be very political
and controversial.
The policy frameworks relating to FDI and FPI are relatively similar, although
there are a few differences.
Direct investors tend to look at a number of factors relating to how they will be
able to operate in a foreign country:

the rules and regulations pertaining to the entry and operations of foreign
investors

standards of treatment of foreign affiliates, compared to nationals of the

host country

the functioning and efficiency of local markets

trade policy and privatization policy

business facilitation measures, such as investment promotion, incentives,

improvements in amenities and other measures to reduce the cost of doing
business. For example, some countries set up special export processing
zones, which may be free of customs or duties, or offer special tax breaks
for new investors

restrictions, if any, on bringing home earnings or profits in the form of

dividends, royalties, interest or other payments

The determinants of FPI are somewhat more complex, however. Because portfolio
investment earnings are more likely to be tied to the broader macroeconomic
indicators of a country, such as overall market capitalization of an economy, they
can be more sensitive to factors such as:

high national economic growth rates

exchange rate stability

general macroeconomic stability

levels of foreign exchange reserves held by the central bank

general health of the foreign banking system

liquidity of the stock and bond market

interest rates

In addition to these general economic indicators, portfolio investors also look at

the economic policy environment as well, and especially at factors such as:

the ease of repatriating dividends and capital

taxes on capital gains

regulation of the stock and bond markets

the quality of domestic accounting and disclosure systems

the speed and reliability of dispute settlement systems

the degree of protection of investors rights

2.5. Foreign direct investment (FDI)

It is defined as a long-term investment by a foreign direct investor in an
enterprise resident in an economy other than that in which the foreign direct
investor is based. The FDI relationship, consists of a parent enterprise and a
foreign affiliate which together form a transnational corporation (TNC). In order
to qualify as FDI the investment must afford the parent enterprise Control over its
foreign affiliate. The UN defines control in this case as owning 10% or more of
the ordinary shares or voting power of an incorporated firm or its equivalent for
an unincorporated firm.

Types of Foreign Direct Investment

1. Greenfield investment:
Direct investment in new facilities or the expansion of existing facilities. Green
field investments are the primary target of a host nations promotional efforts
because they create new production capacity and jobs, transfer technology and
know-how, and can lead to linkages to the global marketplace. Downside of
Greenfield investment is that profits from production do not feed back into the
local economy, but instead to the multinational's home economy. This is in
contrast to local industries whose profits flow back into the domestic economy to
promote growth.

2. Mergers and Acquisition

Transfers of existing assets from local firms to foreign firms takes place; the
primary type of FDI. Cross-border mergers occur when the assets and operation
of firms from different countries are combined to establish a new legal entity.
3. Horizontal Foreign Direct Investment:
Investment in the same industry abroad as a firm operates in at home. Investing
company invest in the same business what they does I their own domestic country.
4. Vertical Foreign Direct Investment:
1) Backward vertical FDI: where an industry abroad provides inputs for a firm's
domestic production process
2) Forward vertical FDI: in which an industry abroad sells the outputs of a firm's
domestic production

Why Has Foreign Investment Increased So Dramatically in Recent

Decades
As stated earlier in this Issue in Depth, international investment levels have
exploded in recent decades. These increases in the flows of foreign investment
have themselves marked a new and distinct phenomenon in the era of
globalization. Several factors have helped drive this growth:
1) Technology: Telecommunications and transportation advances have simply
made it easier to do business across large distances. As former American President
William Jefferson Clinton once pointed out, in the 1960s, transatlantic telephone
lines could only accommodate 80 simultaneous calls between Europe and the
United States. Today, satellites and other telecommunications infrastructure can
handle one million calls at one time.
Fax machines, email and the drop in the cost of air travel have also contributed
significantly to the growth of FDI. As you can imagine, a business owner might
think twice about trying to run an affiliate in a foreign country if communication
with that office were not both easy and cheap. Changes in practices tend to be
driven by changes in capabilities, and these new methods to communicate have
unquestionably helped drive much of the subsequent desire to promote economic
integration.

2)The lure of higher profits: In the 1980s and early 1990s, a number of countries
in East Asia (Hong Kong, Indonesia, Japan, South Korea, Malaysia, Singapore,
Taiwan, and Thailand) began to experience enormous economic growth rates, in
some cases piling up double-digit expansions in their GDP per capita year after
year. These countries had built their phenomenal growth on a foundation based on
greater integration into the international economy. In particular, they
began emphasizing export-led growth. Investors from around the world realized
that access to East Asian markets and their trading partners might help them attain
much higher returns on their investments than they could obtain at home.
3) The fall of the Berlin Wall: The end of the Cold War had an important impact
on international financial liberalization. First, many developing countries that had
previously been committed to socialist models of economic planning began to
turn toward market economies. The resulting efforts to privatize state-owned
enterprises and changes in economic policies that were more favorable to capital
investment made these economies much more attractive to potential investors.
In addition, the demise of the Soviet Union also gave many investors much more
confidence in the political stability of developing countries in general. Fears that a
government might be overthrown or voted out in favor of one that might
expropriate foreign assets declined.
4) Financial liberalization: Prior to the 1970s, many countries, including the
United States, imposed strict limits on the rights of companies and individuals to
invest overseas, to purchase foreign stocks and bonds, or even to hold foreign
currencies. Many of these restrictions were put in place following the Great
Depression of the 1930s, which had produced volatile movements of capital,
triggering financial panics in some cases.
However, in the early 1970s, the United States went off the gold standard and the
previous system of fixed exchange rates between foreign currencies was
abandoned. In addition, many restrictions were lifted on the flows of international
capital, making it much easier for investors to purchase foreign securities. Since
that time, the United States has been in the forefront of efforts to remove
remaining controls on the movement of international capital. The
Reagan, Clinton, and George W. Bush Administrations in particular made deregulation of capital movement a high priority on their international economic
policy agendas.
Financial liberalization has been the most direct, and probably the single biggest,
factor accounting for the growth of international investment flows over the past
several decade

IMPORTANCE AND BARRIERS

The rapid growth of world population since 1950 has occurred mostly in
developing countries. This growth has been matched by more rapid increases in
gross domestic product, and thus income per capita has increased in most
countries around the world since 1950. While the quality of the data from 1950
may be of question, taking the average across a range of estimates confirms this.
Only war-torn and countries with other serious external problems, such as Haiti,
Somalia, and Niger have not registered substantial increases in GDP per capita.
The data available to confirm this are freely available.
An increase in FDI may be associated with improved economic growth due to the
influx of capital and increased tax revenues for the host country. Host countries
often try to channel FDI investment into new infrastructure and other projects to
boost development. Greater competition from new companies can lead to
productivity gains and greater efficiency in the host country and it has been
suggested that the application of a foreign entitys policies to a domestic
subsidiary may improve corporate governance standards. Furthermore, foreign
investment can result in the transfer of soft skills through training and job

creation, the availability of more advanced technology for the domestic market
and access to research and development resources. The local population may be
able to benefit from the employment opportunities created by new businesses

THE ROLE OF MULTINATIONALS AND FOREIGN

INVESTMENT
Foreign direct investment plays an extraordinary important role in inclusive
globalization. It is dramatically increasing in the age of globalization. It has
played important role for
economic growth in this global process. It can provide a firm with new markets
and marketing channels, cheaper production facilities, access to new technology,
products, and skills and financing, FDI has come to play a major role in the
internationalization of business. Reacting to changes in
technology, growing liberalization of the national regulatory framework
governing investment in enterprises, and changes in capital markets profound
changes have occurred in the size, scope and methods of FDI. New information
technology systems, decline in global communication costs have
made management of foreign investments far easier than in the past. Foreign
Direct Investment allows companies to accomplish several tasks like avoiding
foreign Government pressure on local

production, making the move from domestic export sales to a locally-based

national sales office, capability to increase local production capacity,
opportunities for co- production, joint venture with
local partners etc. FDI provide opportunities to host countries to enhance their
economic development and opens new opportunities to home countries to
optimize their earnings by
employing their ideal resources. Smaller and weaker economies and can drive out
much local competition. For small and medium sized companies, FDI represents
an opportunity to become
more actively involved in international business activities. In the past decade,
foreign direct investment has expanded its role by change in trade policy,
investment policy, tariff liberalization, easing of restrictions on foreign investment
and acquisition in many nations, and the deregulation
and privatization of many industries. In present competitive scenario, FDI has
become a prominent source of external finance for developing countries.
From the empirical studies focusing on structural explanations for the movements
in terms of trade, as of yet none have focused on the role of multinational
corporations (MNCs) and foreign direct investment (FDI) even though Prebisch
and Singer themselves have emphasized their role and structuralist strands of the
literature have argued that they were responsible for the tendency of the terms of
trade to deteriorate. and borrowing countries, already highlighting the role of
foreign investment between industrial and developing countries which has to be
understood to be direct investment (as opposed to portfolio investment or other
capital flows, such as aid) without doubt: the productive facilities for producing
export goods in underdeveloped countries are often foreign owned (1950: 474),
and ownership here constitutes control which is the characteristic of direct
investment. According to Singer, this would bring along a certain type of foreign
trade that failed to spread industrialization to the countries in which the
investment took place. Accordingly, this foreign trade-cum-investment based on
export specialization on food and raw materials has reduced the benefits to

underdeveloped countries through falling terms of trade (1950: 477). Also, in

Prebisch contribution, profit transfers between industrialized and developing
countries play a crucial role, although this has barely been recognized in the
literature. The above mentioned labour market asymmetries (cf. section 2.2)
merely bring into force this underlying mechanism that operates through the
business cycle. More precisely, during the upswing a part of profits from the
entrepreneurs at the centre (that is not absorbed by wage increases) is transferred
to the primary producers of the
periphery .During the downswing, however, resistance to a lowering of wages is
high at the centers and the pressure thus moves towards the periphery, The less
that income can contract at the centre, the more it must do so at the periphery
.While most parts of the PST literature have focused on Prebisch characterization
of labour markets as being different between center and periphery, it is important
to stress that Prebisch (1950: 13-14) himself highlights the inequality between
supply and demand in the cyclical centers and the nature of the international
division of labour as sufficient for higher income rises in the industrial than in the
developing countries even if there existed as great a [labour market] rigidity at
the periphery as at the centre see this contribution of Prebisch as the germ of the
idea for dependency and world system theory, the 1970s metamorphosis of
structuralist economics whose core was formed by CEPAL theory that Prebisch
mainly contributed to.
The role of investment in promoting economic growth has received considerable
attention in India since independence. But the role of foreign institutional
investment
or foreign direct investment in the economic development of India is a recent
topic of
discussion among economists and development planners. The Indian government
differentiates cross-border capital inflows into various categories like foreign
direct investment (FDI), foreign institutional investment (FII), non-resident Indian
(NRI) and person of Indian origin (PIO) investment. Inflow of investment from
other countries is encouraged since it complements domestic investments in

capital-scarce economies of developing countries, India opened up to investments

from abroad gradually over the past two decades, especially since the landmark
economic liberalisation of 1991. Apart from helping in creating additional
economic activity and generating employment, foreign investment also facilitates
flow of technology into the country and helps the industry to become more
competitive. FDI and FII are equally connected to investment in a foreign country.
FDI or Foreign Direct Investment is an investment that a parent company builds
in a foreign nation. On the different, FII or Foreign Institutional Investor is an
investment prepared by an investor in the markets of a foreign country. It is with
this aim an attempt has been made in this paper to test the correlation between
foreign institutional investments or foreign direct investment and the real
economic growth in India over a period

IMPACT OF FOREIGN CAPITAL

The recent wave of financial globalization and its aftermath has been marked by a
surge in international capital flows among the industrial and developing countries,
where the notions of tense capital flows have been associated with high growth
rates

(Edwin, 1950) in some developing countries. Some countries have

experienced periodic collapse in growth rates and financial crisis over the same
period. There is an ongoing debate on the pros and cons of Capital inflows i.e. is
there any strong positive connection between foreign capital inflows (FCIs) and
growth? Evidence on this very important question is far from ambiguous, with
China lending support and Brazil negating it. Since 1994, Brazil has attracted
enormous FDI from the developed countries, but neither the growth rate nor the
export prospects have showed commensurate results. The study by Car kovic and
Levin (2002) failed to find strong evidence of positive correlation between FDI
inflows and output growth. The comments made earlier about the feasibility of
economic development without dependence on foreign borrowing are relevant
too. Historically, all of the three countries- Japan, South Korea and Taiwan very
carefully regulated foreign investment inflow during their period of growth

(Griffin, 2009). Theoretical and empirical research on the role of foreign capital in
the growth process has generally yielded conflicting results Conventionally, the
two-gap approach justifies the role of foreign capital for relaxing the two major
constraints to growth In the neoclassical framework, however, capital neither
explains differences in the levels and rates of growth across countries nor can
large capital flows make any significant difference to the growth rate that a
country could achieve (Krugman,1993). Fitz Gerald (1998) theoretically argues
that higher capital inflows lower interest rates, which help increase investment
and economic growth. In their attempt to measure the link between growth and
capital inflows into India, Marwah and Klein (1998) starts by discussing the two
alternative frameworks for analysing the impact of inflows: (a) a macroeconomic
growth model in which the effect of FDI is examined through its effects on the
saving ratio and the capital output ratio and (b) a multifactor production function
is estimated to capture the changes induced by FDI in the relevant parameters.
Adopting framework (b) they assume constant returns to scale and four main
inputs- labour, domestic capital, foreign capital and imports. The econometric
analysis is based on annual observations for the period 1951-89 or appropriate
sub periods. Results suggest that for every one percentage growth point, 0.351 is
generated by growth of domestic and foreign capital nested together, 0.569 by
labour and 0.08 by imports. The contribution of the two types of capital to the
growth in productivity can be allocated in proportion to their respective weights
in the total nest. In this chapter an attempt has been made to establish the
relationship between foreign capital and economic growth of the Indian economy.
The purpose of foreign capital to under developed countries is to accelerate their
economic development upto a point where a satisfactory growth rate can be
achieved on a self-sustaining basis. Capital flows in the form of private
investment; foreign investment, foreign aid and private bank lending are the
principal ways by which resources can come from rich to poor countries. The
transmission of technology, ideas and knowledge are other special types of
resource transfers. Capital flows have begun to play a significant role in Indias
growth dynamics.

The impact of foreign capital in economic growth is much discussed nowadays

but remarkably little analysed. The basic objective of this chapter is to investigate
the causal long run relationship between FCIs and economic growth of India. The
FCIs-growth linkage assumes that the foreign capital inflows provide a significant
amount of contribution to the economic growth. To examine the same, first the
researcher developed a model on the basis of source of financing available to an
economy i.e. domestic capital and foreign capital. After that the researcher
employed co-integration test and Error Correction Model (ECM) technique.

FDI and Economic Development

The bulk of FDI goes, of course, not to developing countries but to developed,
OECD countries in 1999 .77 per cent of total FDI inflows went to OECD
countries And even the minority of FDI that does go to developing countries is
spread very unevenly, with two-thirds of total OECD FDI flows to non-OECD
countries going to Asia and Latin American. However, these FDI inflows do
represent significant sums for many developing countries.4 The nature of these
inflows has altered, though, with more going into mergers and acquisitions rather
than on greenfield investment. Of course, mergers and acquisitions may lead to
human capital development, but it may not, and it may even lead to the opposite,
while greenfield investment would be expected to lead to at least some positive
impact on human capital development. This increasing role of mergers and
acquisitions may therefore undermine the extent to which incoming FDI enhances
human capital development. However, it is impossible to predict either the
motives or outcomes of mergers and acquisitions which in both cases are in any
case extremely mixed and it may be that over time there is little difference

according to what form any given investment started out as. The potentially
positive effects of FDI include inducing incumbent firms to upgrade their
technology, and spill-over benefits so that local competitors can learn from
MNCs technological and managerial practices. The potentially negative effects
include the possibility of MNCs deliberately raising concentration levels, forcing
competitors out of business by predatory pricing, taking away skilled labour and
R&D staff from local firms, or engaging in restrictive business practices
which,among other things, may deter technological development.A well educated
and trained workforce is one of the location advantages that host countries can
provide to attract and retain inward FDI

Human Capital Enhancement

Developing countries need to have reached a certain threshold of development to
be able to fully absorb new technologies. Enhancing human capital can therefore
have a number of beneficial effects, both direct and indirect, for the companies
concerned and also for the wider economy. Firstly, human capital enhancement
can be expected to lead to higher productivity and profitability as a direct result of
the increased capacity of the employees to perform their tasks. Secondly, there is
the indirect effect of companies getting a greater payback than would otherwise
be the case from investment in new technologies and process innovations, as the
employees are better equipped to absorb and utilise both the codified and tacit
knowledge through which the benefits of such investment are largely delivered.
Thirdly, human capital enhancement may improve not just the ability of
employees to deliver greater productivity, but also their willingness, commitment
and motivation so to do. The above effects will be beneficial to the firms in which
the employees work, and thereby to the economy generally. This wider economic
benefit derives not just from the direct contribution of increased output to national

income, but also through vertical linkages with suppliers and others. Labour
turnover, on the other hand, may have rather different implications for the
individual firm on the one hand, and the wider economy on the other. For the
individual firm, some degree of labour stability will be required to ensure that the
benefits from training flow back to the firm rather than moving on to rival firms.
For the economy as a whole, however, such movement may generate positive
spill-over effects. To some extent the successful creation of industrial districts can
internalise what would otherwise be externalities to the firm, so that labour
turnover becomes less costly, as the firm becomes more likely to benefit from
recruiting already skilled labour, and will also benefit from the fact that other
firms within the region are operating at or near the relevant technological frontier.

IMPACT OF FOREIGN CAPITAL ON MACRO ECONOMIC

The endogenous growth theories strongly support the role of FDI in
promoting economic growth in host countries. In these theories, FDI is viewed as
a way to transfer knowledge, promote learning by doing, bring in technology spill
over, and human capital growth. Consequently, FDI stimulates economic growth
in host countries .There are still inconclusive arguments for and against the role of
FDI inflows in enhancing economic growth in a country. Whether FDI inflows are
beneficial or not to economic growth especially in host developing countries are
still debateable among economists. It is therefore very essential to analyse
expected theoretical relationship between FDI and these macro economic
variables before doing empirical investigation regarding their relationship. This
has been discussed below:
Gross Domestic Product:
Gross domestic product(GDP) is defined by the Organisation for Economic Cooperation and Development (OECD) as "an aggregate measure of production

equal to the sum of the gross values added of all resident institutional units
engaged in production (plus any taxes, and minus any subsidies, on products not
included in the value of their outputs)."
GDP estimates are commonly used to measure the economic performance of a
whole country or region, but can also measure the relative contribution of an
industry sector. This is possible because GDP is a measure of 'value added' rather
than sales; it adds each firm's value added (the value of its output minus the value
of goods that are used up in producing it). For example, a firm buys steel and adds
value to it by producing a car; double counting would occur if GDP added
together the value of the steel and the value of the car. Because it is based on
value added, GDP also increases when an enterprise reduces its use of materials
or other resources ('intermediate consumption') to produce the same output.
The more familiar use of GDP estimates is to calculate the growth of the economy
from year to year (and recently from quarter to quarter). The pattern of GDP
growth is held to indicate the success or failure of economic policy and to
determine whether an economy is 'in recession'.

The most widespread belief among researchers and policy makers is that
FDI boosts growth through different channels. It increases the capital stock,
stimulates technological change through technological diffusion and generates
technological spillovers for local firms. Foreign investment is expected to
increase and improve the existing stock of knowledge in the recipient economy
through labour training, skill acquisition and diffusion. It contributes by
introducing new management practices and a more efficient organization of the
production process. As a result, FDI improves the productivity of host countries
and stimulates economic growth in terms of increase in GDP .Investigating the
impact of foreign capital on economic growth has important policy implications.
Positive impact of FDI on economic growth weakens the arguments for restricting
foreign investment in the host country. However the negative impact of FDI on

growth would suggest a reconsideration of development policies adopted by

countries for attracting FDI to enhance the level of their growth

Foreign Exchange Reserves:

Foreign-exchange reserves (also calledforex reserves or FX reserves) are assets
held by central banks and monetary authorities, usually in different reserve
currencies, mostly the United States dollar, and to a lesser extent the Euro,
the Pound sterling, and the Japanese yen, and used to back its liabilities, e.g., the
local currency issued, and the various bank reservesdeposited with the central
bank, by the government or financial institutions
Foreign exchange reserves are the external assets that are readily available
to and controlled by monetary authorities for direct financing of payments. It is
the total of a country's gold holdings and convertible foreign currencies held in its
banks, plus special drawing rights (SDR) and exchange reserve balances with the
International Monetary Fund (IMF).
Foreign investment causes certain advantages like technology transfer, marketing
expertise, introduction of modern managerial techniques and thus creating
immense possibilities of increased foreign exchange reserves in the country
concerned. Foreign investors are generally considered to be better placed to tap
international market than their local counterparts because of their massive assess

to the information and marketing networks of their parent enterprises which

facilitates their efforts to increase foreign exchange reserves in the host country.

Gross Capital Formation:

It is the creation of productive assets that expand an economy's capacity to
produce goods and services. Private savings facilitate capital formation by
allowing resources to be diverted to corporate investment rather than individual
consumption. It is very crucial macro economic parameter which determines the
growth of an economy. Since FDI establishes backward and forward linkages with
local industries, it can also encourage domestic investment by creating an
enabling investment environment through transferring technologies and better
management techniques. Transnational corporations typically have access to a
wide variety of financing options. The risk-adjusted cost of capital is usually
lower for them than the domestic firms in developing countries. Foreign firms can
undertake projects for which domestic investors do not have the capacities to
carry out or which are considered too risky for host country firms. In such cases,
FDI also serves to stimulate domestic investment by further boosting the total host
country investment. FDI not only adds to external financial resources for host
country development, it is also more stable than other forms of financing.
Employment:

Employment is a relationship between two parties, usually based on a contract,

one being the employer and the other being the employee. FDI serves as a catalyst
for rapid economic growth by enabling developing countries to catch up with
advanced economies. FDI plays a major role in the larger development agenda of
the host countries. There is one main social aspect of development such as
employment. Increasing gainful and secure employment has always ranked high
as a policy objective for developing countries. It is a principal means to achieve
an equitable distribution of income and higher standard of welfare for the majority
of the population.
There are three basic mechanisms for FDI to generate employment in the recipient
countries. First, foreign subsidiaries employ people in their domestic operations.
Second, through backward and forward linkages, employment is created in
enterprises that are suppliers, subcontractors, or service providers to them. Thirdly
with the expansion of FDI in related industries, employment is also generated in
different sectors of the economy.
FDI often plays a unique role in employment creation and upgrading of the host
countries because of the special features of foreign investments i.e its tendency to
be larger in size, with greater technological sophistication, and ability to face
more competitive pressures in their product markets as compared to domestic
enterprises.

Exports:
The term export means shipping the goods and services out of the port of a
country. The seller of such goods and services is referred to as an "exporter" and
is based in the country of export whereas the overseas based buyer is referred to
as an "importer". In International Trade, "exports" refers to selling goods and
services produced in the home country to other markets .Methods of export
include a product or good or information being mailed, hand-delivered, shipped

by air, shipped by vessel, uploaded to an internet site, or downloaded from an

internet site.
Exports also include the distribution of information that can be sent in the form of
an email, an email attachment, a fax or can be shared during a telephone
conversation.
FDI is expected to have strong positive relation with the exports volume. This is
quite in tune with common knowledge that export performance is influenced by
technology intensity and hence industry associated with high technology efforts
has a tendency to export high proportion of their product. Country with an
importer of foreign technology can be postulated to have better export
performance. This is the reason to assume an improved export performance of a
country where FDI stake is high.
As exporting involves high degree of risk and uncertainty, so foreign firm with
higher profitability due to greater assess to financial resources do better on export
front. Export-oriented FDI is of higher quality than the domestic market-seeking
FDI. This is because export-oriented companies tend to form micro-level linkages
with domestic firms in the form of sourcing and partnerships.
Their objective is to exploit the low cost infrastructure and cheap labour skill
available locally for export purposes. In addition to knowledge spillovers to local
suppliers, export-oriented foreign firms also cause information spillovers to
purely domestic firms to enter into export market

CONCLUSION
preliminary analysis of FII flows to India and their influence onthe prices of
stocks in the Indian stock market. A more detailed study using daily
data of equity returns for a longer period or, better still, disaggregated
data showing the transactions of individual FIIs at the stock level
can help address questions regarding the extent of herding or returnchasing behavior among FIIs which now account for a significant part
of the capital account balance in our balance of payments. The extent
to which FII participation in Indian markets has helped lower cost of
capital to Indian industries is also an important issue to investigate. Broader
and more long-term issues involving foreign portfolio investment in
India a n d

their

economy-wide

implications

have

not

been

a d d r e s s e d i n t h i s p a p e r. S u c h issues would invariably require an

estimation of the societal costs of the volatility and u n c e r t a i n t y a s s o c i a t e d
with FII flows. A detailed understanding of the nature and
determinants of FII flows to India would help us address such

questions in a more informed manner and allow us to better

e v a l u a t e t h e r i s k s a n d b e n e f i t s o f f o r e i g n portfolio investment in
India