Causal Factors Affecting the Growth Rate of FDI

Abstract

Foreign Direct Investments refers to investments in businesses of interest in a host country by people in another country. Foreign Direct Investment has had steady growth since 1991 during the economic crisis. However, the potential of FDI is still lagging than most of the other developing countries in India. Hence, it is, therefore, necessary to understand the factors affecting FDI in India. This paper looks into the Gross Domestic Product, rates of inflation, and the corruption index and their relationship to Foreign Direct Investments. Data is sourced from the Indian Statistical database for a period of 20 years from 1997 to 2017.

Additionally, real data and indicators are obtained and verified by the Reserve Bank of India. The paper concludes that GDP has a favorable influence on the growth of Foreign Direct Investment. Consequently, the rate of inflation and the corruption index is not statistically significant and thus do not positively impact on Foreign Direct investment.

Introduction

Foreign direct investments refer to investments where companies from other countries control the ownership of a business in a specific company in another country. FDI offers benefits to both the host country and also the foreigner through the spillover effect. In India, foreign direct investment is a significant way of earning revenue for economic progression. Since the economic liberation that started as a result of the financial crisis in 1991, India has experienced steady growth in FDI’s. The main purpose of liberation was to enhance stability in the economy and encourage growth and development. Many foreign companies are investing directly in fast-growing businesses in India and taking advantage of the cheaper wages and changing environments that are conducive to business.

New growth theory shows that FDI creates a lasting effect on growth rate and economy through technology advances and innovations and the spillover effects. It is, therefore, essential to address the determining factors that affect the flow of FDI in a country. In India, many possible determinants affect FDI inflow. In this paper, we look into the Gross Domestic Product (GDP), rates of inflation, and the corruption index yearly and how they affect FDI.

Empirical Section

This section points out that the key purpose of the study is to analyze the effects of the various determinants of foreign direct investments in India. It also states the dependent variable, independent variable, and indicates the hypothesis of the study. This section also explains sources of relevant data used in this study.

Research variables

The study includes the growth of Foreign Direct Investment (FDI) as the dependent variable. In this study, FDI refers to the investment made to cater to the business needs of an investor from a different country apart from their country of origin

The independent variables in this study are the Gross Domestic Product, the rate of inflation, and the corruption index. The Gross Domestic Product in this study refers to the market value attached to all finished commodities and services that a country produces within a specific period. The rate of inflation refers to the increases or decrease in items’ prices for one year. On the other hand, the corruption index refers to the annual ranking of corruption perception levels in public industries.

Hypothesis

The study seeks to determine the relationship between the dependent variable- Foreign Direct Investment and the independent variables, the rate of GDP, inflation rate, and the corruption index.

Null hypothesis

H₀–There is no significant positive impact of the GDP on the growth of FDI in India

-There is no significant positive impact of the rate of inflation to the growth of FDI in India

-There is no significant positive impact of corruption index to the growth of FDI in India

Alternative Hypothesis

H_1-There is a significant positive effect of the GDP to the growth of FDI in India

-There is a significant positive effect of the rates of inflation to the FDI in India

-There is a significant positive effect of the corruption index to the FDI growth in India

Research Data

Data for this study has been taken from the Indian Statistical Database for the period between 1997 and 2017. All the real data and indicators have been extracted from the Reserve Bank of India database.

Statistical Model and Analysis of Results.

The study used inferential data analysis to examine the relationship of the independent variables to the dependent variable. A multiple linear progression model was incorporated. The multiple linear equations were as follows;

Growth rate of Foreign Direct Investment in year t = b₀+ b₁Growth Domestic Product + b₂inflation rate + b₃corruption index

Expressing the equation in a mathematical form;

Y = b₀+ b₁X₁+ b₂X₂ + b₃X₃

Where = the value of the dependent variable(growth of FDI)

b₀₌ Value of Y when all the independent variable (X1, X2, X3) is equal to zero

X_{1 =}value of the GDP

X₂= value of the rate of inflation

X₃= value of the corruption index

b_1, b_2,b₃=estimation of regression coefficients of X₁, X_2,X₃respectively

The results of the inferential data are shown below

Table 1.1

The T-tests were calculated at a 95% significance level.

The table above shows that when the independent variables are equal to zero, the growth of Foreign Direct Investment is less than zero. That means that the FDI in India would not thrive without these other determinants. The results show that unit increase in the growth of GDP results in a 9.9102 increase in the growth of FDI when the other variables are held constant. Additionally, when GDP and corruption index is held constant, every single increase in the rate of inflation would raise the growth of Foreign Direct Investment by 535.679. Consequently, a single increase in corruption index resulted in increasing in Financial Direct Index by 1045.387 when both GDP and Inflation rates were held constant. In the case of the GDP, the p-value is greater than the critical value at 0.95 significance level; hence we fail to reject the alternative hypothesis that an increase in the growth of the GDP does have a significant positive influence on the FDI. Consequently, the rate of inflation and the corruption index is not statistically significant at 0.95 significance level since the critical value is greater than the p-value. Thus accept the hypothesis that both inflation rates and corruption index have no significant positive influence on the FDI.

Table 1.2

The above table shows the different values of the independent variables, GDP Inflation rate, corruption rate, and the corresponding dependent value of the FDI growth rate in the different years. The table shows that an increase in the GDP results in a consecutive increase in FDI. However, in the years when the inflation rate increased, it resulted in a decrease in FDI. For example, in 1998, the inflation rate increased from 7.16 to 13.23 leading to a decrease in the FDI from 3613 to 2614, even though the GDP increased. Also, there are some years where an increase in the corruption index resulted in a decline in FDI despite an increase in the GDP and a decrease in the Inflation rate.

Conclusion

The purpose of this study was to show the connection between the dependent variable (Foreign Direct Investment) and the Gross Domestic Product, the rate of inflation, and the corruption Index (the Independent variables. The results of this study show that the Gross Domestic Product has significantly influenced the growth of FDI positively. Better market potential ensures that foreign firms have enhanced profitability. Thus it means that a rise in the GDP would be an incentive in attracting foreign firms to base their businesses in the country. On the other hand, the test for both inflation rates and corruption index was not statistically significant. This result means that the variables do not have a significant impact on Foreign Direct Investments in India positively. A rise in the rates of inflation hinders Foreign Direct Investment, especially when price levels are high since it becomes expensive due to the high-interest rates and high cost of capital. Consequently, moderation of inflation allows investments and growth of the economy hence attracting foreign firms. On the other hand, corruption has a negative effect on foreign investments. Corruption is one of the greatest obstacles to economic and social development, and thus most of the foreigners stay away from such countries since the business is much riskier.

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Causal Factors Affecting the Growth Rate of FDI