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Capital Flows into India: Implications for Its Economic Growth Author(s): Tanushree Mazumdar Source: Economic and

Political Weekly, Vol. 40, No. 21 (May 21-27, 2005), pp. 2183-2189 Published by: Economic and Political Weekly Stable URL: http://www.jstor.org/stable/4416675 . Accessed: 17/03/2014 06:58
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It was hoped that with the partial liberalisation of the capital account in the-early 1990s, capital inflows would contribute towards India's econonic growth. This paper reviews the role of capital flows into India and examines if such flows have in any way contributedto economic growth. The model developed by this paper suggests that capital inflows have not contributed towards either industrial production or economic growth. Either the amount of capital inflows has not been enough or the amountsflowing in have not been properly utilised. At the same time, studies also indicate that capital inflows have not had much inipact on India's export growth or productivity.

ne of theobjectivesof theNew EconomicPolicy(NEP), 1990-91of thegovernment of Indiain opening thecapital accountwas thatcapitalinflows to the countrywould contribute to exports and output growth, after a lag [GoI the flow of foreigncapital 1991]. While the NEP accelerated to India,especiallyportfolioflows, Indiahas always received foreigncapitalin the form of FDI and otherforms for a long time. Therefore,it would be interestingto review the role of capitalinflows to Indiaand examine if they have in any way contributed to India'seconomic growth. The paperis organisedin the following manner.Section I brieflyreviewstrendsin literature examiningthe role of capital inflowson growth.. SectionIIpresents a briefsurveyof literature examiningthe impactof capitalinflows on economicgrowth. SectionIII outlinesthe hypothesisand containsdetailson the variables InSectionIV themodel chosen,dataandmethodology. is estimatedand the results are reportedand analysed, and SectionV summarises the findings.

Inflows andEconomic Growth: Capital Focus Shifting

In the entiregamutof literature exploringthe macroeconomic of capitalinflows,perhaps the mostcontroversial consequences andalso the mostinconclusiveaspectrelatesto the relationship inflows between to capital inflowsandgrowth. As barriers capital acrossseveral inthelate1980sand1990s, countries werelowered theregrewa consensus (ledandreinforced amongpolicy-makers Woodstwins)of the beneficialeffects of capital by the Bretton inflows especially on growth. This was in keeping with the the of the mainstream economistswho also emphasised thinking growth inducing effects of capital inflows especially FDI [Bailliu 2000]. Twofactors wereresponsible forsuchoptimism: (i) the'miracle' of the east Asian countries,which experienced II high growthin thewakeof openness, thatledto higher inflows,(ii) neglect Capital capital Inflows andGrowth: Literature Survey of thepossibility of sudden of capitalinflowswhich withdrawals Studieslinkingcapitalinflows to growthmerelyexpandon coulddestabilise the economy.This optimismprevailed despite the fact thatKrugman (1979) and Flood and Garber (1984) in the existingtheoriesof growth.Thereareno modelsor theories theirfirst-generation crisis models had predicteda speculative designedespeciallyto explainthe impactof capitalinflows on to thesemodels, economicgrowth.The theoriesgrowthcan be dividedinto two attack onfixedexchange rateregimes. According Economicand PoliticalWeekly May 21, 2005 2183

current accountdeficit or an expectedmonetisation increasing of fiscal deficit triggersoff speculation. Agents startbelieving thatthe government's need to financeits deficit wouldmakeit difficultfor it to defendthedomesticcurrency. Thiscausesthem to shift theirportfoliofrom domesticto foreigncurrencyand eventuallycauses the fixed exchangerate to collapse. This shiftin focusfromlong-term to short-term, frombenefits causedthediscussion/debate to damages, on theeffectsof capital inflows on growthto take a backseat,as it were, in the 1990s. thatexamined Thestudies theimpact of capital inflowson growth the issue with caution.Studiesbegan to focus on approached the regionalvariationvis-a-vis the growth-inducing effects of the observations out of these studies were inflows; capital arising restricted to those regionsalone ratherthangeneralising them and forminga theory.Thus, it was found that privatecapital inflows were associatedwith higherlevels of domesticinvestment in sub-Saharan Africa than in east Asia and that capitalinflows only fuelled consumption in Latin America Bank 2001]. [World Recentstudies[Calvoet al 1998;Dooley 1999]amongothers) now decomposecapitalinflows into FDI, portfolioinvestment, thanuse the generic'net capitalinflows' capital,rather banking to examinethe effects on variousmacroeconomic indicators, includinggrowth.Finally, a crucialpoint noted in the studies post-crisis,is that investment- whetherfinancedby foreign to fastergrowth. capitalor not - does not necessarilytranslate In the past,considerable emphasiswas placedon capitalaccumulationas a meansto foster growth[Lewis 1955]. However, et al 2001] a new bodyof evidence[Lipseyet al 1996;Easterly indicatethatit is not changein the 'level' of capitalstock but thatpromotes changein 'totalfactorproductivity' growth.This however,is not the final standtakeneitherby the theoretical availableon the subject.A brief survey or empiricalliterature of literature will reveal this.

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schools of thought:the neo-classicalor exogenous theory of growthandthe endogenoustheoryof growthalso knownas the New Theoryof Growth. Theneo-classical modelsof growththat prevailedin the 1950s and 1960s were pioneeredby Solow (1956), Swan (1956) amongothers.The main highlightof the neo-classical modelsof growthwas theproperty of convergence of growthrates.The modelspredicted thatcountries with lower real per capitaGDP would have higherlevels of growthrate. This derived from the assumptionof diminishingreturnsto capital.Assuminggrowthin labourand technologyto be zero, as per growthin outputwas a functionof capitalaccumulation the neo-classicaltheories.Within the framework of the neoclassicalgrowth model,FDI(a formof capital inflow)couldexert a level effect on outputper capitabecauseof augmented investment but not on the growthrate of output[Solow 1997]. The foreconomicgrowth,as perthe neo-classical thrust models,was andhadto comefromoutsidethesystem,mainlyfrom exogenous technologicalprogress. In the 1980s the old growththeory(the neo-classicalschool) gave wayto the new growththeorywithRomerandLucasbeing The most important the most prominent departure proponents. of the new theoryfromthe old was thatit believedgrowthrate to be endogenous. The new growththeoryis also knownas the in thistheory theoryof growth.Thekey assumption endogenous to scale made was a belief in the operation of increasing returns possibleby sustainedincreasein capitalinvested(bothhuman increase and physicalcapital).This would createa permanent in thegrowthrateof an economy.In the New Theoryof Growth role was given to the humancapital[Lucas1990]. an important of nations Lucassuggestedthatthe differencesin productivity wereowed to the differencesin the skill level andabilityto use technologyof the workersacross nations. on the 'ideagap' between Thenew growththeoryemphasised developedand developingcountries,which made the former, grow at a higher rate than the latter. The new theorygives importanceto 'innovation'in technology as an explanatory factorto the growth rate in any economy [Grossmanand fromthepointof view ]. Itviewseconomicgrowth Helpman1991 of new technology of 'creativedestruction',i e, introduction wouldhelp countriesclimb up in the 'qualityladders'of technology which in turnwould lead to highergrowthrate of the economy. The effect of technology'spillovers'on economicgrowthis another theory putforthby the endogenous argument important of growth[Aghionand Howitt 1998; Howitt 2000]. The sum of indirecteffects of technologicalchange on the rest of the as spillovers. Anytechnological progress economycanbe termed into highergrowthrate for the economy. thus can translate of the world economies in the form of open Globalisation channel,at least theocapitalaccountsprovidedan important in adeveloping whichgrowth rates, particularly through reticaily, neo-classical As the could be increased. theoryof per country which inflowswouldaddto capital accumulation, capital growth, could lift the potentialtrendcurve of growth.To believersof the endogenous theory of growth, capital flows could help countries bridgethe 'idea gap' in the developingcountriesas capitalflows involved exchange of ideas [Romerand Rivera FDI flows couldimpact of technology,through 1990].Transfer R&D of developingcountriesin that they could stimulateininthehostcountry novation [Grossman growth enhancing thereby and Helpman1991].

for developingcountries,capitalinflows Thus, theoretically, havea lot of appealbecauseof theirgrowthenhancing potential. evidenceon this is equivocal.Some studies However,empirical a positive between inflowsandeconomic report relationship capital growth in different developing countries throughenhanced investment[Bosworthand Collins 1999; World Bank 2001]. Othersreportpositive relationship betweenFDI and economic growthin countrieswith higherabsorptive capacityespecially the absorptive et al capacityof its humancapital[Blomsrtom 1992; Borenszteinet al 1998]. As mentioned, beforeempiricalsupport for theoretical argumentslinkingcapitalinflows to economicgrowthis shrouded inambiguity. Somestudies norelationship havereported between inflows and and Xayavong 2001; [Gounder capital growth Carkovic andLevine2002].Somerecentstudieshavechallenged for reapingbenefitsfrom foreign the humancapitalargument investmentflows. The mixedfindingsof empirical studiesseems to cautionone towards abouttheeffectof capital hastyanyconclusions drawing inflows on growth.At the basic level it drawsour attention to differencesin the sample period, methodologyand countries selectedthatcouldaffectthe outcomeof theresults.At a deeper of growthenhanclevel, however,it suggeststhattheexperience ing effects of capitalinflows has been variedacrosscountries on theirexistingconditions. In thispaperwe examine depending the relationship betweencapitalinflows and economicgrowth in Indiafor a periodof 30 years and see if our resultspredict the outcomeof theoryor not.

Ill of Growth: Inflows on Economic Impact Capital TheIndian Experience

in Indiabeganonly Thoughthe capitalaccountliberalisation in 1993-94, Indiahas a historyof capitalinflows in the form of external assistance the 1950s),external assistance and (during (duringthe 1960s), externalassistance,forforeigninvestment commercial NRIdeposits external borrowings, eign investment, andothercapital sincethe 1970s.Economic growth beinga longits causalfactorsarebest studiedovera long termphenomenon, rather thanrestrictitself to the study periodof time.Therefore, of theimpact of capital inflowson economicgrowthin the 1990s, of examining thisstudyuses datafromthe 1970sfor thepurpose the impactof capitalinflowson growthin India.The dataused is of annualfrequency. Hypothesis and Variables Selected The hypothesisin the paperis based on the experienceof developing countrieson the growth related experiencewith in theliterature above).The surveyed capitalinflows(asoutlined to Indiahave tests the inflows paper followinghypothesis: capital contributed to its economic growth. The paperfollows the model outlinedby Barro(1990), i e, of growth onnumber of variables. These theindicator is regressed variables(specifiedbelow) are selectedto control explanatory formacroeconomic conditions andother factors growth. affecting To this, dataon net capitalinflows are added.An evaluationis made to see if there is a relationship betweencapitalinflows and growththat is independentof other variablesassociated with growth.
Economic and Political Weekly May 21, 2005


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fromthe calculation Economicgrowthis usuallyproxiedby the growthrateof per has beendropped of net capitalinflowsand of capitalinflows has been used to components capitarealGDPin a country.However,we do not use percapita the remaining real GDP as the dependentvariablein our study as this series calculateournetcapitalinflows.Rupeedebtservicecomponent exhibitsan I(0) processin its level (realpercapitaGDP)as well of netcapitalinflowsis essentiallydebtowed to Russiadenomias in its growthrate(growth ratein realpercapitaGDP)whereas natedin rupeesandconverted at current exchangerates,payable alltheexplanatory variables exhibitanI(l) process.We therefore in exports.This debtowed to Russiawas almostnil (as reported chooseIndex of Industrial Production of statistics) variable in the RBI's handbook (IIP)asadependent duringthe 1970sand 1980s. in one model and non-agricultural real GDP (NAGDP)as the In the 1990s, these constitutedonly outflows and since it did variablein the second model. The choice of IIP as not cause any loss of foreignexchange;therefore, omissionof dependent a proxyfor economicgrowthis for two otherreasons.First,IIP this variableshould not affect the results much. In addition, is significantly correlated withrealGDP(0.97 witha significance removingthiscomponent makesthe dataon net capitalinflows level of 0.01) as well as with the realoutputof the servicesand an 1(1) process,makingit amenableto be used in this study. financialsector (0.99 with a significance level of 0.01) and thereforeserves as a robustproxy for economicgrowth.Two, Model, Data and Methodology IIPis foundto be a reliableleadingindicator of businesscycles in India[Mall 1999; Nachaneet al 2002]. Most of investment As mentioned above,annualdatahavebeenusedin this study flows sincetlTe andservices from 1971-72to 1999-2000.The choice of the periodof study late 1980shavebeenin theindustrial thatIIP is used as our dependent is dictatedpurelyby the availabilityof a completedata series sector,it is most appropriate variable. with respectto all variables.For the sake of maintaining conThe reasonfor the choice of non-agricultural incomeis very sistency,dataon IIP and WPI have been convertedto a single variables form,havemostly base periodprice (1993-94 = 100). All explanatory simple.Capitalinflowsto India,in whatever flowedto theindustrial andservicesector.Therefore, of GDP to putthem agricultural (theirrealvalues)aretakenas a proportion the true in perspectiveover the 30-year period. This also serves the incomefromthe GDP is removedto be able to capture of containing theproblem All data of heteroscedasticity. impactof capitalinflows on economic growth. purpose of Statistics Ideally speaking,one must use growth rates as dependent have been takeneitherfrom the RBI's Handbook of theCentral variablesto studyeconomicgrowth,in this case growthin IIP orvarious bulletins Statistical monthly Organisation andgrowthin non-agricultural GDP. However,it is foundthat (CSO) and RBI's annualreports(variousissues). in In termsof a model, use is made of a semi-log functionof growthratefiguresof IIP as well as NAGDP are stationary theirlevels thatis theyexhibitanI(0) stochastic variable processwhereas conventional growthequationin which the dependent the explanatory in theirfirstdifference, is regressed ona number of explanatory variables. All explanatory variables are stationary areexpectedto carrya positivesign andbe statistically data variables i e, I(1) stochastic process.Resultsbasedon suchincoherent would not be useful for analyticalpurposesand thereforethis significant.The semi-log specificationis as follows: advancement paperchoosesto proxyeconomicgrowthor rather lnY= + pnfc+ ygov + 6expimp+0 + liq+ pcapinf+ut.... (1) agri data of The level IIP and NAGDP. the through log values of In the aboveequation,lnY is the proxyfor economicgrowth. IIP and NAGDP are also stationaryin their first difference. NAGDP.Amongthe explanavari- Inthiscase, IIPandalternatively, Therefore, lnIIpandlnNAGDPare used as the dependent ablesin the two models.The implication of this is thatthis study tory variables,nfc is non-food credit to GDP ratio, gov is to GDP ratio,expimp is exportsplus to levels in IIPandNAGDP government expenditure pointsoutthefactorsthatcontribute and as the aim imports(tradeopenness)to GDP ratio,agri is agriculture in Indiarather thangrowthin them.This is adequate inflowshaveinanywaycontributed allied industries'income to GDP ratio, liq is liquid liabilities of thisstudyis to see if capital incomein India.Capital (financial to industrial depth)to GDPratio,andcapinfis usedto denotecapital outputor non-agricultural inflowshavea roleto playin the levels of IIPandNAGDP,they inflows to GDP ratio. As regardsmethodology, this study uses multipleregression would also enhancegrowthin them. of observations variables areselectedlargelyfromthe litera- analysis,as the number The explanatory (N=30) is too smallfor time series techniques. To begin with, turesurveyed above.Thesearetradeopenness(exports+imports the use of sophisticated of the variablesare tested. macroeconomic as a ratioof GDP),inflationto capture stability, stationarity as a ratioof GDPas itformsanimportant government expenditure of demandand supply(therebystimulating IV growth) component and financialdeepening(the ratio of liquid liabilitiesto GDP Estimation of Model andResults and allied industries ratio).Besides these, outputof agriculture on the selectedvariables, Beforerunning unitroot variableas Indiahas been has been includedas an explanatory regression ADF in is tested for test eachof the variables. health for and the an agrarian a time even using Stationarity today economy long for using OLS. Resultsare preet al of variablesis a pre-condition sectoraffectsindustrial of the agriculture output[Nachane 2002]. The paperalso includesnon-foodcreditto GDP ratioas sentedin Table 1. in their As is evidentfromTable 1, all variables arestationary of businesscycles in Indiaandcanexplain it is a leadingindicator is in level. first difference which its net inflows And of variations in industrial inflation, course, capital except stationary output. of GDP) are includedin the list of explanatory Therefore,the data on inflationis omittedfrom the analysis. (as a proportion areperformed on two variants of themodel A wordon the net capitalinflows used in the study: Stepwiseregressions variables. variableandthe otherwith the actualdataon net capitalinflows were found to be an I(0) (i e, one using IIP as the dependent all theexplanatory variables exhibited NAGDP)including asagainst theI(1)stochastic stochastic processes process, exceptinflation. inthefinalmodelonlythoseexplanatory is toinclude thedataon 'rupeedebtservice' Theobjective Therefore, by theothervariables.
Economic and Political Weekly May 21, 2005 2185

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Figure 1: Actual versus Estimated IIP

5.4 5.1 4.8

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industrial growthhas been foundto be robustin countrieslike Taiwan,SouthKoreaandJapan[Changet al 2001]. Therefore, the resultsfor India are neitherexceptionalnor surprising. A positiverelationship is foundbetweenindustrial production andgovernment expenditure. Theoryhas not been able to combetweengovernpletelyresolvethe disputeon the relationship mentexpenditure andeconomicgrowth.At best,theorypredicts a negativerelationship shouldexist in rich countrieswith large
Table 1: Unit Root Tests for the Variables (Sampleperiodfrom1973 to 2000) Variable Observations 30 28 30 28 30 30 28 30 28 30 28 30 28 30 28 ADFValues (Cal) Critical Values -2.05 -4.67*** 0.71 -4.04*** -3.8 -1.26 -7.54*** -1.45 -4.34*** -2.62 -8.14*** -0.81 -5.42*** -1.58 -4.08*** -3.57 -3.58 -3.57 -3.58 -3.57 -3.57 -3.58 -3.57 -3.58 -3.57 -3.58 -3.57 -3.58 -3.57 -3.58

relationship between agriculturalincome and industrial production in India is not difficult to understand as India has been an agrarian economy and even today rural demand for industrial products depend on the performance of the agricultural sector in a given year. The link between agriculturalproductivity and

variables, which can statistically explain the relationship with IIP, the dependent variable.

of the Model(usingInllP as the (i)Firstvariant variable) dependent

The behavioural equation is as given in equation 1. Stepwise regression gives us three alternate equations. Of these we chose the one with the maximum variables. The results of the stepwise regression are reported in Table 2. It may be mentioned that all the four equations reported an R bar square value of more than 71 per cent. Of all the equations reported above, we chose equation number 1C as it contains the maximum numberof variables. To this, the dataon capital inflows are added to get the single equation behavioural equation as reported in equation (1) above. The equation is now as follows: Iniip= a + 3nfc+ygov+ 8expimp+ Oagri+Xliq+pcapinf+ ut ...(1 a) Results of OLS are reported in Table 3. In the above equation, Durbin Watson (DW) statistic at 1.1 is quite low which is natural as it is possible for growth models to be incorrectly specified. Therefore, there would be some autocorrelation problemas the model would be eitheroverspecified or underspecified. However, if the signs of the coefficients are as per expectation, one may accept the results as true. Besides, the DW statistic is higher than 0.511. Therefore, according to the CRDW (Cointegrating Regression Durbin Watson) test, the above data series are cointegrated. In other words, the above results from the regression may not be spurious. The F-statistic of the equation suggests that the coefficients arejointly not equal to zero and points to the robustness of the results. The paper checked for multicollinearity and found that the explanatory variables display no problem of multicollinearity, except for capital inflows. This is expected as capital inflows is a redundant variable in the above equation. In other words, the data on capital inflows do not add to the explanatory power of the equation and hence may be dropped from the equation all together. Coefficients from equation 2 are used to estimate past values of InIIP to test the goodness of fit of the model. It is found that the model has a reasonable goodness of fit as estimated figures of lnIIP are quite close to the actuals (Figure 1).

LnllP InllP(dl) Expimp/GDP Expimp/GDP(dl) Inflation+ Govexp/GDP Govexp/GDP(dl) Agriallied/GDP Agriallied/GDP(dl) Capinf/GDP Capinf/GDP(d1) Liqliab/GDP Liqliab/GDP(dl) LnNAGDP InNAGDP(dl)

Notes: Inthe above Tabledl stands forfirstdifference.AllADFtests include an intercept termas well as a lineartrend+ Non differencedseries is ** at 5 percent level, *** at 1 percent stationary, Stationary Stationary level. Table 2: Results of Stepwise Regression Model Unstandardised StandarCoefficient dised Coefficients B Std Error Beta .03 .21 .03 .68 .51 .06 1.148 .63 1.049 .98 1.298 -.323 .95 -.531 .55

t 115.34 31.92 101.86 12.86 -3.199 53.62 5.62 -4.216 2.44

Sig .000 .000 .000 .000 .004 .000 .000 .000 .022

1A (Constant) 3.451 Gov expenditure to GDP 6.693 1B (Constant) 3.385 Gov expenditure to GDP 8.803 Tradeopenness -1.632 1C (Constant) 3.256 Gov expenditure to GDP 6.455 Tradeopenness -2.688 and allied Agriculture activitiesto GDP 2.563 Note:Dependentvariable: InllP.

Table 3: Results of OLS for Equation la Dependentvariableis InllP Variable Independent Constant Govexp Tradeopenness Agriculture Capinf R barsquare DW F statistic Coefficient 3.29 6.57 -2.54 2.06 2.37 0.98 1.1 401.167 t-statistics 53.6** 5.6** 4.2** 2.4* 0.89 P-value .000 .000 .001 .034 0.382 .000

Analysis of Results
From Table 2, it can be seen that of all the possible factors

the levels of government affectingindustrial production, expenditure and agriculturalincome are important.The positive

Notes: **significant at 1 per cent level, * significantat 5 per cent level.


Economic and Political Weekly

May 21, 2005

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in Folsteret al 1999].Thisis because publicsectors[summarised of thedifference in composition in richand of publicexpenditure countries. In the more than half countries the poor poor governmentexpenditure is directed toward and schooling,infrastructure subsidiesin R&D,etc. On the otherhand,in the richcountries, namely OECD countries,less than one-fifth of government is on headsthatenhancegrowth.In fact, evidence expenditure pointsto thefactthatin the richcountries, government spending privatesaving (through pre-empts highertax rates)and crowds out privateinvestment(throughthe increasein interestrates). In a developingcountrylike India,the government is a producer, consumer,regulatorand is also a primaryinvestorin infrastructure andR&D facilities.Therefore it is not surprising to find a positiverelationship betweengovernment expenditure and industrial in our country.Moreover,the public production sector has also been a large employerin India and that could haveindirectly contributed to demand forindustrial As of output. in the sector accounted 2000,publicsector employment organised for 69 percentof totalorganised sectoremployment [Economic would obviouslygenerate Survey2001-02]. Such employment substantialamount of consumption expenditure as well as savings from private individuals and would create demand for industrialproductsas well as source for supply of funds. The results obtained also point to a negative relationship betweentradeopennessandindustrial in India.That production is to say thatgreaterthe tradeopenness,lower is the level of industrial Orhigher thelevel of industrial production. production, loweris ourlevel of exportsandimports. This is not surprising. Theoretical literature as well as empirical evidenceon the effect of trade oneconomicgrowthas well as industrial openness output findsthe relationship to be ambiguous. For instance,Grossman andHelpman andSala-i-Martin (1991)andBarro (1995),believe that increasedopenness brings in better technology through importof goods and this helps in enhancingthe productivity increasein the efficiencyof production through process.On the otherhand,LevineandRenelt(1992) suggestthatopennessmay stimulate directinvestment fromabroad, buttheincreased foreign international domesticinvestmay also discourage competition ment. In this case, the outputeffect of the two drivingforces is ambiguous, on thechangesin domesticandforeign depending investment. Batra (1994),Learer (1995)andBatra Alternatively, andBeladi,Hamid thatfreertrade is theprimary (1992)alsoargue source of economic downturns.Trade liberalisationand increasedopennessarebelievedto reducetariffs,andtherebythe tariffcut reducesthe relativeprice of domesticmanufactures. In this case, manufacturing goods domesticallybecomes less thanimporting attractive foreigngoods, andhencethe domestic economy may suffer a loss. Empiricalevidence supportsthe ambiguity of theoretical constructs with respectto tradeopennessand growth.Thereis some evidencesuggestingnegativerelationship betweentrade and in India Inthelight [Das 2003]. openness export productivity of this, our resultsmay be pointingtowardsthe rightdirection. Itwouldrequire a detailed ornottrade studyto concludewhether in India. has hurt industrial However, opennessreally production this is beyondthe purviewof this study and thereforewe tentativelyacceptthe aboveresultsto be truesince it satisfiesmost of the statisticalrequirements of robustness. The insignificantrelationshipbetween capital inflows and in Indiais not surprising industrial as the quantum production of capitalinflowsto GDPhasbeenmeagre(Table4). At its peak,
Economic and Political Weekly May 21, 2005

net capital inflows to India have been little above 4 per cent of the GDP. This is much lower than countries like China, where capital inflows have often been as high as 20 per cent of its GDP [Shan et al 1997]. In India, after the capital account was partially liberalised in sector (about 1993-94, foreign investment flowed to infrastructure 30 per cent of total foreign investment between 1991 and 1999) and service sector, namely telecommunications (about 17 per cent) and finance (about 8 per cent). Since a good amount of capital has been flowing to the services sector and infrastructure, it would be appropriate to broaden the scope of our study by including these two sectors along with the industrial sector for the purposeof studying the impact of capital inflows on economic growth. Therefore, it would be more appropriateto look at the contributionof net capital inflows to India on the non-agricultural economic growth. This brings us to the second variant of the model, which tests the impact of net capital inflows on nonagricultural income in India. In this case the level of nonagricultural GDP is taken as a proxy for economic growth.

of the Model as a (ii)Second Variant (usingInNAGDP dependent variable)

The behavioural equation for the second variant of the model is as follows = a + r3nfc + ygov + &expimp + Oagri + Xliq+ pcapinf+ Innagdp ut...(2) In the above model, lnnagdp is the log of non-agriculturalGDP e, (i GDP minus income of the agricultureand allied industries). As with the first variantof the model, we use stepwise regression to eliminatestatisticallyirrelevantvariables.Results from stepwise regression are reported in Table 5. Table 4: Net Capital inflows to India
(as percentageof GDP) Year 1970-71 1974-75 1978-79 1980-81 1984-85 1988-89 1990-91 1994-95 1996-97 2000-01 Source:Owncalculationsbased on data fromRBI. Net CapitalInflows 0.15 0.15 0.33 0.33 0.76 1.90 2.17 3.80 4.44 3.41

Table 5: Results of Stepwise Regression

Model Unstandardised StandarCoefficient dised Coefficients B Std Error Beta 11.941 6.555 11.923 8.469 -1.708 11.814 7.162 -3.897 2.593 .02 .15 .02 .84 .74 .04 .90 1.049 .95 .99 1.282 -.294 1.084 -.671 .57

t 530.53 41.56 534.38 10.04 -2.305 262.34 7.96 -3.715 2.70

Sig .000 .000 .000 .000 .029 .000 .000 .001 .012

1 2 3

(Constant) to GDP Gov expenditure (Constant) Gov expenditure to GDP Financial depth (Constant) Gov expenditure to GDP Financial depth and allied Agriculture activitiesto GDP

Note:Dependentvariable: LNNONAGR.


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Figure 2: Non-Agricultural GDP (Actual vs Estimated) 13.8013.60 13.40

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Figure 3: Outstandings 0.700 1

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of Commercial Banks

incomein India.One reasonfor this negative non-agricultural income and financial relationshipbetween non-agricultural depthcould be thatexpandingfinancialactivity is not getting to increasedeconomic activityas the funds arenot translated being used for investment.In the periodafter 1995, one finds thatbanksin Indiahave been allocatingtheirfundsin government paper rather than lending it to industry (Figure3). in Indiais slowly withdrawing itself Besides, the government fromthe sphereof production and therefore, the fundsare not of investment. it is quite Similarly, beingutilisedforthepurpose that financial has meant an increase in possible deepening only the treasury of financialinstitutions rather thana rise operations in theirlendingactivity.However,these are only possibilities, which need to be exploredbeforeone can arriveat any definite conclusion. The relationship betweencapitalinflowsandnon-agricultural GDPis positivebutstatistically Theresults arethus insignificant. similarto findingsfrom the first variantof the model.

a)4o ?) 0.400

__ ** -* -

V of Findings Summary
Economicgrowth in any countryis financedeither by its domesticsavingsor foreignsavingsthatflow into the country. Prior tothefinancial sectorreforms thatledto thegradual opening upof the Indian economy,we hadto largelydependon domestic savingsto give impetusto our growth.Though,foreigncapital didflow intothecountry in theformof aid,external commercial and NRI borrowings deposits,it did not and was not expected to contribute muchtowardsour capitalformation or economic growth. After 1993, when the capital account was partially it was hopedthat capitalinflows would contribute liberalised, towards oureconomicgrowth.However,resultsfromourmodel towards either suggestthatcapitalinflows havenot contributed industrial or economicgrowth.The reasoncouldbe production twofold.One, the amountof capitalinflows to the countryhas not beenenough.Two, the amountof capitalthatdoes flow in, is not utilised to its full potential.It is also possible that a combination of boththe factors,i e, inadequate foreigncapital as well as underutilisation of the capitalinflows explains lack of relationshipbetweencapitalinflows andeconomic growth in India. This authorhas not come acrossany comparable studiesfor theroleof capitalinflowson economicgrowth. India,examining However,studieshave examineda relatedaspect, namelythe impactof capitalinflowson India'sexportproductivity/growth. These studies have concludedthat capital inflows have not to exportgrowthor productivity contributed et [Subrahmanian al 1996;Banga2003; Das 2003]. WhileFDI has contributed to
Table 6: Results of OLS for Equation 2
DependentVariableis InNAGDP Coefficient 11.81 7.06 -3.75 2.63 3.13 0.98 1.24 609.749 Variable Independent Constant Govexp Liq(financial depth) Agriculture Capinf R barsquare DW F statistic t-statistics 246.3** 7.36** 3.26** 2.67* 1.2 P-Value .000 .000 .001 .015 .752 .000

g 0.300 o 0.200

C C0 O O

0a) C) C)



C 0)

C) 0)


0) 0) 0)


C 0O

a, U, i ) C0 0) 0) 0) 0) ',',_,-


IN C)0) 0 0) 0)


0 0

0 0




It may be mentioned that the R bar square value for each of the equations was more than0.66. Stepwise regression eliminates non-food credit, capital inflows and trade openness from the behavioural equation. Within the three single equation models provided by stepwise regression, we use equation number three as it includes maximum numberof explanatory variables. To this, data on net capital inflows are added and the results obtained are presented in Table 6. Coefficients generated by equation (2) are used to estimate past values of non-agriculturalGDP. It is found that the coefficients are quite reliable as the estimated values are very close to the actual figures of non-agricultural GDP (Figure 2).

Analysis of Results
Results in equation 2 are similar to those in equation (la) in the sense that the statistical characteristics, viz, F-statistic, collinearity statistics are also very similar to equation la. Moreover, they emphasise the importance of government expenditure and agriculturalincome, in this case to explain variation in the level of non-agricultural GDP in the country. The nature of the relationship too remains the same, i e, there is a positive relationship between these two explanatory variables and the dependent variable. The results suggest a negative relationship between the level of non-agriculturalincome and financial depth of the economy. This is a little surprising, as financial depth is known to help in the growth of the industrial and financial sector. A little more

investigation is required to be able to definitely conclude that increasingfinancial depthnegatively affects the level of

Note:**significant at 1 per cent level, *significantat 5 per cent level.


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May 21, 2005

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some diversification in our exports,it has not contributed to its FDI not seems to have contri2003]. growth[Banga Similarly, buted muchtoourexport either[Das2003].Analysis productivity of the exportperformance of FDI firmsvis-A-vis the local firms reveal thatFDI-stake is notasignificant orpositive factor explaining variationsin export performance et al 1996]. [Subrahmanian Whileexportsandeconomicgrowtharetwo differentvariables andstudiesrelating to themarenot strictlycomparable, theydo serveas pointers. Itmay,therefore, be inferred thatevidencedoes notsuggestanystatistically impactof capitalinflows significant on India'seconomicgrowth.fl i Email:tanusml@yahoo.com

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