Do Bilateral Investment Treaties Promote FDI Inflows? Evidence from India

Abstract

Executive Summary In view of the catalytic role of foreign direct investment (FDI) in promoting economic development, countries adopt various unilateral as well as bilateral arrangements to create a conducive environment for FDI. One such significant form of arrangement is bilateral investment treaties (BITs). As sizeable cost and resources are involved in treaty formation, it becomes important to examine the potential benefits of BITs for investment and whether such measures actually translate into higher FDI flows. This article employs panel data regression on an augmented gravity model (under both static and dynamic conditions) to identify the determinants of FDI inflows into India with a special focus on the role of BITs. The panel data span over the period 2001–2012 and include the top investing countries in India accounting for around 92 per cent of India’s total FDI inflows. The explanatory variables employed are extended market size, vertical FDI drive, distance, colonial links, common language, political stability, financial openness, and population growth rate. BIT is incorporated as a dummy variable which takes the value 1 if a BIT exists between India and the investing countries in a given year, otherwise 0. The results for both the fixed effects and the two-step generalized method of moments (GMM) model specifications confirm the positive role of BITs in attracting FDI inflows into India. BITs have contributed to rising FDI inflows by providing protection and commitment to foreign investors contemplating investment in India. The model also finds support for other factors facilitating FDI such as the large size of the economy and a more liberal FDI regime. As attracting FDI is an important policy objective of developing countries like India, the results imply that one of the instruments of achieving this objective is for the government to negotiate BITs with countries which are prospective investors. By laying down clear guidelines with respect to investment and widening the scope of investment activities covered under a bilateral agreement, an environment of certainty is created which would facilitate FDI flows.