FDI, Public Investment and Private Domestic Investment in India: Crowding in or out?

Abstract

This study is a novel attempt to explore the relationship among private domestic investment, FDI and public investment in India. The Johansen cointegration test indicates the cointegrating relationship between the variables of interest during the time period 1978 and 2014. The VECM shows that both FDI and public investment have crowded in private domestic investment in the long-run. Public investment crowds in domestic private investment in the short-run also but FDI tends to crowd out domestic investment in the short-run. The short-run negative relationship between FDI and PDI may be attributed to the fear of intensive competition, pre-emptive and brownfield investment by the foreign investors. But in the long-run, as the vertical linkages are established between FDI-backed firms and domestic ones, FDI inflows also crowd in domestic investment. The error correction term is found highly significant with the expected negative sign implying speedy convergence to long-run equilibrium after a shock. The dummy variable that has been introduced to capture the impact of reforms in the aftermath of 1991 bears a statistically significant and positive sign. Which implies that reforms of 1991 have positively influenced PDI. The causality test shows that there exists bi-directional causality between private domestic investment and public investment but unidirectional causality between FDI and PDI running from FDI to PDI.