Is There Any Relationship Between Foreign Direct Investment, Domestic Investment and Economic Growth in India? A Time Series Analysis

Abstract

It is argued in the existing literature that foreign direct investment (FDI) inflow positively influences economic growth through technology diffusion, human capital formation, etc., though a section of the literature do not find empirical support for this contention. Since the initiation of the economic reforms in India in 1991, the role of foreign investment in the growth process has been acknowledged by the policy makers. Greater emphasis on FDI inflow has been laid in recent years by allowing 100 per cent FDI in various economic activities. In this background, the present analysis attempts to understand the nexus between the investment and economic growth in India. A time series analysis is undertaken to analyse whether there exists any long-run relationship between FDI, domestic investment and economic growth, and if so, what is the direction of the relationship. While the long-run cointegrating relationship between FDI, gross fixed capital formation (GFCF) and gross domestic product (GDP) in India is confirmed by the empirical analysis, the findings that there is a unidirectional causality from India’s economic growth to FDI and from FDI to domestic investment raises important policy implications. Higher FDI inflow in India in recent period can be argued to be facilitated by the relatively stable GDP growth rate, which in turn acted as a major boost towards a sustainable high domestic investment. The growth effects of the FDI on GDP in the short run are, however, less pronounced.