Cointegration and Causality Between Foreign Direct Investment, Trade and Economic Growth: Empirical Evidence from India’s Post Economic Reform Period

Abstract

International trade and capital flows are the key macroeconomic indicators of a country’s balance of payment, and they impact the real economy. This study estimates the long-run association between exports, imports, foreign direct investment (FDI) and economic growth since India’s economic reform in 1991 until 2019. Johansen multivariate cointegration method has been adopted to study this association and to develop long-run cointegration model. The augmented Dickey–Fuller test results show that variables are non-stationary at level and stationary at first difference. The cointegration model suggests a long-run relationship among GDP per person employed (GDPPE), exports, imports and FDI. The result shows that exports are the major determinant and positively influences the GDPPE whereas imports and FDI negatively influence GDPPE. The imports affect GDPPE more negatively than FDI. The vector error correction model finds long-run causality from GDPPE, exports and imports towards FDI and short-run causality from GDPPE towards FDI, imports towards FDI and GDPPE towards exports. The policy focus should be on export promotion and to closely watch the causal effect of labour productivity on FDI and exports, and imports on FDI.