The Causal Linkage Between FDI and Current Account Balance in India: An Econometric Study in the Presence of Endogenous Structural Breaks

Abstract

In 1991, as per the recommendations of the International Monetary Fund (IMF), India followed a structural adjustment programme. The new economic philosophy shifted towards export-oriented growth model, where augmenting competition in the domestic market through reforms in licensing provisions and adoption of better technological capabilities through foreign direct investment (FDI) collaborations have played an extremely important role. Over the last decade, the high economic growth in India, resulting from the reforms, has motivated massive FDI inflows into the country. The continuous inflow has caused India’s share in the global FDI inward stock to increase from 0.08 % in 1990 to 0.22 % and 1.03 % in 2000 and in 2010, respectively. However, the improved FDI scenario in India has simultaneously witnessed a decline in the current account balance (CAB) of the country. In this background, the current chapter attempts to explore the underlying long-term co-integrated relationship between FDI inflow in India and CAB by analysing quarterly data over the period 1990–1991:Q1 to 2010–2011:Q4. Our result indicates that there exists a unique long-run relationship among FDI and CAB with two endogenous structural breaks. The analysis also reveals a unidirectional causality from India’s FDI to CAB at 5 % level. First, the findings imply that although FDI may seem beneficial as a source of financing for the current account deficit, it may eventually lead to balance of payments (BOPs) problems due to adverse effects on current account. In this respect, even the role of FDI on economic growth can be questioned. Second, the huge outflow of foreign exchange from the country in recent years in the form of profit remittances raises concerns over the optimality of allowing 100 % profit repatriation.