ResearchersWorld -Journal of Arts, Science & Commerce ■ E-ISSN 2229-4686 ■ ISSN 2231-4172

A STUDY ON THE IMPACT OF FDI INFLOWS ON EXPORTS

AND GROWTH OF AN ECONOMY: EVIDENCE FROM THE
CONTEXT OF INDIAN ECONOMY

Ms. Rashmita Barua,

Asst. Prof., Dept. of Humanities & Social Sciences,
Assam Don Bosco University, Guwahati, India

ABSTRACT

It needs little emphasis that a nation’s international competitiveness today crucially depends upon
the growth and technological dynamism that it adopts. Economic policymakers, therefore, go out
their way to attract Foreign Direct Investments (FDI), as a high level of FDI is viewed as a catalyst
of economic growth for the host country. This paper thus examines the two most important
benefits associated with the inflow of FDI for the host country in the form of: Export Promotion
and GDP Growth.
To study the dynamics of co-integration between FDI, GDP and Exports, evidence is taken from
country-specific level like Indian Economy where the period of study is from 2000-2012. As FDI
inflow can have a two-way impact on the host country, hence, the paper firstly examines the
current economic scenario of India in terms of its FDI inflows, GDP growth rate and its export
performance so far. Secondly, the paper shows a positive correlation between FDI, GDP and
Exports by framing Simple Regression and Multiple Regression Models built on the hypotheses
formulated and validating the results of the models based on ANOVA and Durbin-Watson test.

Keywords: FDI, Exports, GDP, correlation.

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 ResearchersWorld -Journal of Arts, Science & Commerce ■ E-ISSN 2229-4686 ■ ISSN 2231-4172

INTRODUCTION:
The International financial scenario has been exhibiting a phase of transition since the last two decades, where
capital flows in the form of foreign aid have dried up, and financial institutions like World Bank and IMF alone
have not been able to meet up the needs of the developing countries. Hence, economic policymakers of
developing economies go a long way in attracting capital flows in the form of Foreign Direct Investment (FDI)
as a high level of FDI is viewed as an affirmation of the future economic health of that country. Generally
speaking, FDI refers to the capital inflows from foreign country that invests in the productive capacity of the
host country. FDI has therefore become a vital component of the developmental strategies adopted by almost all
nations across the globe. In fact, FDI provides a win-win situation to both the ‘investing country’ as well as to
the ‘host country’. The investing country can take advantage of the free market accessibility that it gets in the
host country. The host country on the other hand can increase its financial resources for development, boost
export competitiveness, and increase its labour productivity by strengthening its skill base and enhancing
technological capabilities.
The role of FDI in the growth process of the host country has long been a topic of discussion. Several of the
discussions and studies reveal that there is a strong and positive correlation between FDI and growth. Apart
from acting as an engine for technology transfer (or diffusion), FDI also stimulates domestic investment,
international trade, expand domestic savings, increase its foreign exchange reserves thereby correcting its
Balance of Payments position. All these factors together contribute towards the growth of a nation.
Exports, on the other hand, is also considered as an instrument of economic growth and facilitates efficient
production of goods and services by gaining comparative advantage over other countries. The success stories of
East and South-East Asian countries suggest that FDI is seen as a powerful tool of export promotion for the
domestic country. Several studies have also confirmed that FDI through multi-national corporations (MNCs)
have greater advantages over domestic firms in respect of export performance. Foreign firms bring with them
many intangible assets in the form of technology, skills, brand names, advertising strategies, globally
established marketing channels and experience of operating in international markets. Therefore, foreign
countries can be instrumental in promoting exports from the host countries. As more and more exports help lead
a country to increase its foreign exchange reserves and build a strong financial position, therefore, it can be
rightly said that FDI can not only increase the export base of the domestic country but also contributes to the
overall growth of the host country.
Thus, the paper tries to show an inter-relationship between FDI, exports and growth, and the sample evidence is
derived from the relevant data of Indian Economy. Hence, the first section of the paper deals with the data used
and the methodology adopted for the study. The second section of the paper emphasizes on analyzing the current
economic scenario of Indian Economy in terms of its total FDI inflows, its GDP growth rate over the years and
growth of exports from a period of 2000-2012. The final phase of the paper deals with the formulation of
hypotheses and studies the correlation between the three variables by adopting simple and multiple regression
methods. The results are further validated through the use of ANOVA and Durbin-Watson test.

LITERATURE REVIEW:
A number of econometric studies have been done in the recent past to prove the validity of the relationship
between FDI infusion in an economy and economic growth. A panel data analysis was done to examine the
relationship between Foreign Direct Investment (FDI), financial development and economic growth using
Generalized Method of Moments in a group of 70 developed and developing countries from 1988 to 2002
(Choong and Lam, 2011). It was found that FDI has a negative and significant impact on economic growth in
developing countries. The interpretation for the negative sign of FDI is that the weak regulations and the low
degree of the financial sector development in developing countries lead to misallocation of this private capital
flow, which reduces and even reverses its impact on economic performance. The finding supports the notion
that a certain level of financial sector development is a significant and prerequisite for FDI to have a positive
effect on economic growth. The major findings of the study are that FDI generally has a positive impact on the
economic growth rate of countries. To host country, FDI offers much more than necessary investment as it
raises the factor productivity as well as enhances the ability to better integrate the domestic industries with
global markets. A time-series analysis was also employed to prove the causal relationship between FDI and
economic growth of Bangladesh using annual data from 1975 to 2005 (Md. Gazi Salah Uddin and Md.
Wahidul Habib, 2008). The Granger Causality test and Error Correction Models were employed taking care of
stochastic properties of the variables. Time-series analysis indicates the causal nexus between export, FDI and

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 ResearchersWorld -Journal of Arts, Science & Commerce ■ E-ISSN 2229-4686 ■ ISSN 2231-4172

growth. The results indicated that FDI and exports are co-integrated and suggest a one-way causation from FDI
to export growth. This implies FDI causes export growth in the long-run but does not influence in the short-run.
In the last three decades, FDI flows have grown rapidly all over the world. This is because many developing
countries see FDI as an important element in their strategy for economic development. The FDI has both
benefits and costs and its impact is determined by the country’s specific condition in general and the policy
environment in particular. The relationship between FDI and economic growth is very controversial as it varies
from country to country. The basic objective of this paper was therefore to investigate the causality between
economic growth and FDI in India and China. Ganesh Kumar (2011) examines the direction of causality
between FDI and GDP for India and China using the Granger Causality test. In addition to the studies made
which dealt with assessing the overall impact of FDI on growth, a study made by Singh (2011) focused on the
impact of foreign investment on host country industrial structure with special reference to India’s manufacturing
sector during post reform period. Moreover, the core variable of the study namely foreign presence indicated
positive and significant association with industrial market concentrations.
Roy and Mandal (2009), examined the dynamics between economic growth and FDI for a selected group of
Asian economies namely India, China, Hong Kong, Malaysia and Philippines. This paper examined the issue of
crowding-in or out effect between foreign and domestic Investment in the long-run. Although it may be seen
natural to argue that FDI can convey great advantages to host countries. Laura (2003) showed that the benefits
of FDI vary greatly across sectors by examining the effect of FDI on growth in the primary, manufacturing and
services sector. An empirical analysis using cross-country data suggested that total FDI exerts an ambiguous
effect on growth. Another paper (Ilan, 2007) investigates the impact of foreign direct investment (FDI) on
economic growth using detailed sectoral data for FDI inflows to Indonesia over the period 1997-2006. In the
aggregate level, FDI is observed to have a positive effect on economic growth. However, when accounting for
the different average growth performance across sectors, the beneficial impact of FDI is no longer apparent.
When examining different impacts across sectors, estimation results show that the composition of FDI matters,
for its effect on economic growth with very few sectors showing positive impact of FDI and one sector even is
showing a robust negative impact of FDI inflows.
A study made by Balamurali (2004) examines the relationship between foreign direct investment and economic
growth of Sri Lanka for the period 1977-2003 using Johansen’s full information maximum likelihood method
by considering relationship between real gross domestic product, foreign direct investment, domestic
investment and openness of the trade policy regime. The results indicate that foreign direct investments exert an
independent influence on economic growth and there is bidirectional causality between foreign direct
investment and economic growth.

OBJECTIVES OF THE STUDY:

• To study the impact of FDI on the growth of an economy.
• To substantiate the need of FDI for promotion of exports and analyze the relationship between exports and
FDI.
• To study the correlation between FDI, GDP and Exports.
• To study the dependency of GDP growth on exports and FDI.

DATA AND METHODOLOGY:

Since the sample evidence has been taken from the context of Indian Economy, therefore, this study uses
secondary data to prove the validity of the topic. The data under study has been mostly collected from RBI
Statistics Database on Indian Economy from the period of 2000-2012.
The first section of the paper deals with the study of the current economic scenario of India in terms of total FDI
inflows, FDI inflows on a sectoral basis, growth of GDP and its export performance over the years.
In order to fulfill the objectives of the study, few hypotheses have been formulated based on the variables in
question, which have been further validated through the use of statistical tools like Simple Regression and
Multiple Regression Models and Correlation analysis. The statistical significance of the variables is explained
through the use of ANOVA and Durbin-Watson test.

CURRENT ECONOMIC SCENARIO OF INDIAN ECONOMY:

a) Magnitude of FDI Inflows in India from the period 2000-2012: The historical background of FDI in India
dates back from the time when East India Company was established in India with the objective of setting up
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units in India. This is how railways came into being in India. If we examine the current state of FDI inflows
in India, it can be seen that there has been an exponential increase in the flow of FDI in India with more
liberalized reforms coming into being. But on the other side of it, it is also seen that with years to come,
there has been some volatility in its flow. But if we see, FDI again picked up pace because of automatic
approval route via RBI.

Figure 1: Total FDI Inflows (Rs. Billion) in India from the period 2000-01 – 2011-12 (Source: RBI)

b) FDI Inflows by Sector in India: According to UNCTAD (2007) Investment Report, India has emerged as
the second most attractive destination for FDI after China. Indian policymakers continue to make concerted
efforts to make India an attractive destination for FDI and reap the benefits out of it. While it is clear that
FDI inflows into India have been on the rise, let’s now analyze the sources as to where the flow of FDI is
most. It is clear from the figure below that India has attracted significant overseas Investment in service
sector over the years. The other sectors mentioned below too have been able to bring considerable
investment over the years.

Figure 2: Cumulative FDI Inflows (in Rs. Billion) on a sectoral basis from the period 2000-12
(Source: Department of Industrial Policy and Promotion (DIPP), Govt. of India)

c) GDP growth rate of India from 2000-2012: Figure below gives a clear picture that the GDP of India has
been constantly on a rise. India has witnessed a robust growth rate since 2000 with services sector to be one
of the major contributors of GDP. It can thus be summed up that FDI has played a major role in the increase
in growth rate of the various sectors of India.

Figure 3: GDP at Factor Cost (Rs. Billion) of India from the period 2000-01 – 2011-12 (Source: RBI)

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d) Growth of exports in India from 2000-2012: Exports in India too have seen a steady increase with
increase in GDP. One of the reasons for this sharp increase in exports is because India has been able to
diversify its exports base from agricultural based products to manufacturing products.

Figure 4: Total Exports (Rs. Billion) in India from the period 2000-01 – 2011-12 (Source: RBI)

FORMULATION OF HYPOTHESES:
To meet the objectives of the study, following hypotheses have been formulated:
1. Null Hypothesis (Ho): There is no significant relationship between FDI and Exports.
Alternative Hypothesis (H1): There is significant relationship between FDI and Exports.
2. Null Hypothesis (Ho): There is no significant relationship between FDI, GDP and exports.
Alternative Hypothesis (H1): There is significant relationship between FDI, GDP and exports.

TESTING OF HYPOTHESES AND DATA ANALYSIS:

To examine the significance of FDI on exports and growth, firstly Pearson’s correlation coefficient is computed
between FDI & exports, FDI & GDP, GDP & Exports. The results are analyzed by considering the values of
FDI inflows, GDP and exports of India from the period 2000-2012.
Table 1 (Source Author)
Correlations
FDI Exports
Pearson Correlation 1 .916**
FDI
Sig. (2-tailed) .000
Pearson Correlation .916** 1
Exports
Sig. (2-tailed) .000
**. Correlation is significant at the 0.01 level (2-tailed).
Table 2 (Source Author)
Correlations
FDI GDP
Pearson Correlation 1 .926**
FDI
Sig. (2-tailed) .000
Pearson Correlation .926** 1
GDP
Sig. (2-tailed) .000
**. Correlation is significant at the 0.01 level (2-tailed).
Table 3 (Source Author)
Correlations
GDP Exports
Pearson Correlation 1 .99**
GDP
Sig. (2-tailed) .000
Pearson Correlation .99** 1
Exports
Sig. (2-tailed) .000
**. Correlation is significant at the 0.01 level (2-tailed).

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Since the correlation coefficients between the three variables are fairly high, therefore, the null hypothesis in
both cases is rejected in at confidence interval of 0.01and alternative hypotheses are accepted. The results
clearly indicate that there is significant relationship between FDI, growth and exports.
To further understand the dependency of these three variables, following models have been built based on
Simple Regression and Multiple-Regression Analysis.
MODEL 1: The first model is based on Simple Regression analysis to explain the dependency of Exports on FDI.
EXPt = α + β FDIt + e …………………………………………….. (1)
Where, EXPt = Exports
FDIt = Foreign Direct Investment
e = Error or Disturbance term
Table 4 (Source Author)
Coefficients
Coefficients
Model 1 t
β Std. Error
(Constant) 1588.548 791.184 2.008
FDI 4.729 .656 7.207
Dependent Variable: Exports

Table 5 (Source Author)

ANOVA (Model Summary)
Std. Error
Adjusted
R of F-
Model R R Durbin-Watson
Square the test**
Square
Estimate
1 .916a .839 .822 1680.60626 51.947 .891
a. Predictors: (Constant), FDI
b. Dependent Variable: Exports (** Significant at 0.01 level)

From Model 1, it is found that all the variables are statistically significant. The regression result confirms that
FDI is an important factor for increase in exports in the country. It is observed from the results that elasticity
coefficient between FDI and export is 4.72 which imply that 1% increase in FDI may cause 4.7% increase in
exports. Hence, FDI positively influences exports. The coefficient of determination i.e., R2 shows that the model
has a good fit as 82% of exports is being explained by FDI. F-test also confirms that the variables are
statistically significant. The D-W statistic shows that there is no autocorrelation problem in the analysis.

MODEL 2: Model 2 is based on Multiple Regression Analysis to prove the dependency of GDP on Exports and FDI.
GDPt = α + β1FDIt + β2EXPt + e ……………………………………….. (2)
Where, GDPt = Gross Domestic Product
EXPt = Exports
FDIt = Foreign Direct Investment
e = Error or Disturbance term
Table 6 (Source Author)
Coefficients
Coefficients
Model 2 t
β Std. Error
(Constant) 11278.818 1384.214 8.148
FDI 2.752 2.412 1.141
Exports 4.667 .467 9.992
a. Dependent Variable: GDP

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Table 7 (Source Author)

ANOVA (Model Summary)

Adjusted R Std. Error of

Model R R Square F-Test** Durbin-Watson
Square the Estimate

2 0.994 .988 .986 2482.233 377.918 2.112

a. Predictors: (Constant), Exports, FDI
b. Dependent Variable: GDP (** Significant at 0.01 level)
In the growth model (Model 2), estimated coefficients on FDI & exports have a positive relationship with GDP.
Therefore, it is statistically revealed that FDI and Exports are instrumental in influencing the level of economic
growth in India. The coefficient of determination i.e., R2 explains that 98% level of economic growth is being
influenced by FDI and exports in India. The F-test also confirms the significant relationship between FDI,
growth and exports. The D-W statistic is 2.11 which confirm that there is no autocorrelation problem in the
analysis.

FINDINGS OF THE STUDY:

Following are the findings of the study:

CURRENT SCENARIO OF INDIAN ECONOMY:

• India’s share in global FDI has increased considerably over the years, but the pace of FDI inflows has been
slower than that of China.
• Due to the initiative taken in respect of continued Liberalization since 1991, India has been witnessing a 7
plus percent of economic growth. In fact, India’s economic growth even touched 9 percent since 2006. India
has been considered to be one of the fastest growing economies of Asia.
• It is also seen that cumulative inflows of FDI has been on a constant rise with sectors like services,
construction proving to be the most attractive destinations for FDI. Services Sector have alone received Rs.
171,345 crores of FDI from 2000-12.
• It is also observed that major FDI inflows in India are concluded through the automatic route via RBI.
• It is also worth mentioning that exports have been consistently increasing in the last 12 years along with
increase in GDP. If we compare exports as a percentage of GDP, the results seem to be quite favorable for
India as a large chunk of GDP is contributed by export sector in India.

IMPACT OF FDI ON EXPORTS AND GROWTH:

• The results of the export model (model 1) shows that both the variable included under study are statistically
significant. The elasticity of coefficient between exports and FDI is positive which indicates that 1%
increase in FDI can increase 4.7% of exports.
• In the GDP model (model 2), the variables under study proved to be statistically significant indicating that
FDI and exports play a vital role in accelerating the GDP of Indian Economy.
• The study also shows that FDI & exports, FDI & GDP, GDP & Exports are all positively and highly
correlated with each other which pave the way for rejecting the null hypotheses and accepting the alternative
hypotheses under consideration.

CONCLUSION & POLICY RECOMMENDATIONS:

The study clearly reveals that FDI not only acts as a vehicle for accelerating the pace exports but it is also an
important variable that alters the level of GDP of the host country. FDI can complement local developmental
efforts by boosting export competitiveness, generating employment and strengthening the skill base, enhancing
technological capabilities (transfer, diffusion and generation of technology), and increasing financial resources
for development. It can also help plug a country in the international trading system, as well as promote a more
competitive business environment. In view of this, India should continue to take steps to ensure an enabling
business environment to improve India’s attractiveness as an investment destination.
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But there have been a few elements of concern for India. According to the latest reports published by Economist
Intelligence Unit (EIU, 2007-11), FDI inflows in India are set to increase substantially but would remain well
below potential. The report says that ‘India’s potential to attract increased FDI inflows is vast, although poor
infrastructure, excessive bureaucracy, labour market inefficiencies, and interdepartmental wrangling will slow
the pace of opening in many sectors’. Therefore, it is highly recommended to the policy makers of India that
drastic steps must be taken to improve infrastructural facilities and increase labour efficiencies which can be
seen as a restructuring tool to increase FDI inflows in India. It is also recommended that focus should not be on
the absolute amount of gross FDI inflows, but also the on the type of FDI inflow as it is seen that FDI inflow in
India is mostly concentrated through M&A. There is hardly any Greenfield Investments being taken place so far.
Finally, India should consciously work towards attracting greater FDI into R&D as a means of strengthening the
country’s technological capacities.
Although policy makers are looking at FDI as the primary source of funds, but it must be taken into
consideration that FDI is not the only solution of rapid growth and development. India needs to put in place a
comprehensive developmental strategy which includes being open to trade and FDI.

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