Journal of International Trade Law and Policy

Emerald Article: Determinants of foreign direct investment in India Monica Singhania, Akshay Gupta

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To cite this document: Monica Singhania, Akshay Gupta, (2011),"Determinants of foreign direct investment in India", Journal of International Trade Law and Policy, Vol. 10 Iss: 1 pp. 64 - 82 Permanent link to this document: http://dx.doi.org/10.1108/14770021111116142 Downloaded on: 18-04-2012 References: This document contains references to 23 other documents To copy this document: permissions@emeraldinsight.com

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JITLP 10,1

Determinants of foreign direct investment in India

Monica Singhania and Akshay Gupta
Faculty of Management Studies (FMS), University of Delhi, New Delhi, India
Abstract
Purpose The purpose of this paper is to examine the determinants of foreign direct investment (FDI) in India. Design/methodology/approach Using macroeconomic variables GDP, ination rate, interest rate, patents, money growth and foreign trade the authors tried to nd the best t model (ARIMA (p,d,q)) to explain variation in FDI inows into India. The authors tested for various assumptions taken before applying autoregressive integrated moving average (ARIMA) such as heteroscedasticity, autocorrelations, etc. using standard tests and quantied FDI policy changes using dummy variables. Findings It was found that of all macroeconomic variables taken, only GDP, ination rate and scientic research are signicant and that FDI Policy changes during years 1995-1997 have had a signicant impact on FDI inows into India. Research limitations/implications The authors econometric model explains 63 percent variation in FDI inows into India. Implicitly, the balance 37 percent variation in FDI inows is still unexplained and so further study should be undertaken with even wider scope in terms of macroeconomic variables such as exchange rate, etc. Practical implications As a recommendation for future FDI policy planning and implementation, the authors suggest the Government of India gives resources towards variables that have been classied as signicant in this paper, namely GDP growth and ination rate and should open the economy further. Sectors not yet open to FDI investments should be opened and although ination rate should be controlled but some ination is benecial. Originality/value There has been no authoritative study until now to nd Determinants of FDI inow to India and this paper also goes a step forward and presents accurate models that can be used to forecast FDI inows based on the macroeconomic variables considered. Keywords India, International investments, Macroeconomics Paper type Research paper

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Journal of International Trade Law and Policy Vol. 10 No. 1, 2011 pp. 64-82 q Emerald Group Publishing Limited 1477-0024 DOI 10.1108/14770021111116142

I. Introduction Worldwide foreign direct investment (FDI) represents a major source of funding for capital intensive projects. This is more so for emerging economies including India. As a result of persistent tapping of this source of fund by emerging economies in the last two decades, the FDI level as of now stands at approximately 35 percent of global FDI in emerging economies. In 1991, India adopted a massive liberalization program and since then FDI inow has been increasing tremendously in India. The main objective of the liberalization program was to bring stability, economic growth and development via the liberalization, privatization and globalization (LPG) program. The liberalization policy of Indian Government of 1991 emphasized undertaking regulatory measures such as deregulations, tax reforms, initiation of privatization and opening Indian economy to investments from abroad. Implicitly, it resulted in restructuring of its previous trade regime to ensure greater integration of the Indian economy with other international economies. Since 1991, Indian economy has made rapid strides towards integration with world economies and has been able to establish a mutually benecial inter-linkage with them.

In a way, the major structural changes under the economic liberalization program continued till 1995. As India moved from policies of import substitution to export promotion, it was able to attract more and more FDI. In addition, several other factors favoured Indian economy such as economic growth above global average, fast growing population with ever increasing young population and consumers, lower interests rates and relatively stable nancial systems, lower wages and production costs, low ination rate and increasingly reformed exchange rate system, etc. These factors ensured that India continued to attract an increasingly large chunk of FDI and as of now, India has become the second favorite destination for FDI inows for next three years (Ernst & Young, 2010). Figure 1 shows FDI inow in India from 1991 to 2008. Broadly, theories on the determinants of FDI can be bifurcated into two separate sets of theories (Yang et al., 2000). The rst set of theories analyse FDI in the context of portfolio allocation framework and second set of theories analyse FDI ow in the context of market imperfections. According to portfolio allocation framework FDI ow depends on factors such as international differences in prot ratios, interest rates and/or other measure of return to investment. Market imperfections-based theories states that FDI ow happens when production is favourable in host country rather than exporting. The focus under the second category is on the main advantages that a host country could provide in terms of location, i.e. geography, which determines its FDI ows. II. Theoretical framework The variables selected for the study have been decided by taking into consideration the relationship and importance of the variable in the context of the Indian economy and the availability of adequate data to enable the process of undertaking an empirical study. The econometric model that we plan to study is: AFDI f AGDP ; Openness; Inflation; Interest Rate; Money Growth; Scientific Progress
FDI in flow in India 30,000 25,000 In $ million 20,000 15,000 10,000 5,000 0

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1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Year Source: World Bank Databank, http://data.worldbank.org/country/india

Figure 1. Adjusted FDI Inow

JITLP 10,1

where: AFDI AGDP Foreign direct investment adjusted for GDP deator (unit million). GDP adjusted for deator (unit $ million). Sum total of imports and exports as percentage of GDP (percent). Ination rate calculated as percentage change in Consumer Price Index (CPI) (percent). Real interest rate (percent). Quasi money growth (percent).

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Openness Ination Interest Rate Money Growth

Scientic Progress Patents application led (in number). There are several studies and literature to signify the importance of each of the selected independent variables in determining the inow of FDI in any country. With increase in GDP, it is expected that companies abroad will like to be part of the success story and start putting money in such an economy. Similarly for an increase in openness, which has been denoted by the total trade as percentage of the GDP, as the trade with other country increases, any country is able to attract more money as investment. The ination rate decides the nal value of the returns of the investment on the money invested in the country and so is again an important determinant of the FDI inows. Real interest rate signies further source of money and relatively stable and low interest rate helps in better nancing of the projects along with FDI money. At the same time, the scientic progress in the country along with money growth also helps in attracting FDI money. We plan to undertake regression analysis and determine if there is a way to predict the FDI inows using the dened variables as far as the future is concerned. This will help in testing whether a positive or a negative relationship holds true between the selected variables and FDI. We will also be able to check the extent to which the determining factor out of all these factors is in variation to the FDI inows as given. This analysis will enable companies to predict, if possible, the probability of FDI inows (in case allowed in their respective sectors) and in this way look for this alternate important source of project nancing. III. Literature review Studies done abroad There have been numerous studies done for determinants of FDI inows for various countries. This literature review draws from past studies and provides an explorative view of the relationship that FDI inows have with its determinants. As far as the relationship between FDI and a countrys economic growth is concerned, the issue is still open to debate. Usually, the level of productivity in a country is the measure of its economic growth and this depends on the way countries use their resources, such as labour forces, stock of capital and technology. Countries lacking in natural availability of these resources need to rely on foreign investment in order to accumulate the necessary resources for investment in their country. Fedderke and Romm (2006) suggest that in case

a country does not have the requisite technology, resources and skills, these can be provided by FDI through the spillover effect. However, the capacity of the host country to absorb these resources and generate growth successfully depends upon its policies. World Bank denes stable business environment in Collier and Dollar (2001) and the ability to create such an environment is one of the most important policy aspects for any country. From a series of studies of the actual effect or lack thereof of FDI on a countrys economic growth, Moran, et al. (2005) have concluded that the effect of FDI on the host countrys growth depends to a great extent on the host countrys economic openness. The more liberalized the economy, the more likely the positive benets of FDI to be transferred to the host country. Likewise, the more restricted the economy, the more negative the impact of FDI on growth. Analyzing 39 Sub-Saharan African countries, Seetanah and Khadaroo (2007) found that though the contribution of FDI is small when compared to other growth factors, it not only contributes to but also follows from economic growth. Though many studies seem to imply that FDI directly equals growth, as a consequence of spillover of resources, Nonnemberg and Cardoso De Mendonca (2004) however nd that while strong GDP growth can induce FDI inow, FDI does not necessarily induce economic growth. The study uses China as an example to demonstrate this point. China is one of the largest developing economies in the world with one of the highest rates of growth. This, in turn ensures that China is also one of the largest recipients of FDI. But there is little evidence to show that such FDI contributes towards Chinas growth. In the econometric model formulated in the study, a lagged dependent variable is included to incorporate the market response to the changes in the economy. Incidentally, this variable is signicant in the nal model of the study. Carkovic and Levine (2002) nd that FDI does not induce economic growth independently. Microeconomic conditions of the country such as the host countrys specic competitive advantage and its business environment are also important in the relationship between FDI and growth and the authors also suggest that past studies have ignored the lagged effect between these two variables, thus giving a distorted view. Studies conducted in Argentina and Estonia reveal that although MNCs employ more skilled labour and higher spending on training, there is very little effective difference in knowledge levels and technology when compared to domestic companies of the same size. Alfaro (2003) nds that the impact of FDI on growth varies across sectors. The benet depends on the spillover potential of the industry. Other studies also highlight the fact that the benets of FDI on growth cannot be generalized across different countries or sectors. Each market has certain specic conditions that could enhance or hinder these benets on the host countrys economic growth. However, despite these contradictory views on the relationship between FDI and growth, it is still highly recommended that emerging markets should actively pursue FDI (Odenthal and Zimmy, 1999; Jenkins and Thomas, 2002; Nwankwo, 2006). This positive attitude towards FDI is not only based upon the understanding that there are potential benets from the spillover of technologies and skills, but also the fact that FDI is a highly resilient form of capital ow for the host country. Investments via FDI are less likely to be withdrawn during nancial crisis when compared to other forms of foreign nancing such as portfolio investment. The host country economys state of openness is also a relevant factor. While on one hand in case the host country has a relatively closed current account, there are incentives

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for FDI as a channel to bypass trade barriers. On the other hand, a relatively closed capital account, for, e.g. restricted foreign ownership, may lead to discouraged FDI ows. A signicant empirical research in related eld has provided convincing evidence that FDI is a signicant factor in economic growth in developing countries but the effect being restricted to relatively open and export-promoting countries. Various studies have been conducted on determining factors that inuence FDI inow into a host country. These include economic factors such as the target countrys market size, income level, market growth rate, ination rates, interest rate and current account positions, while others are socio-economic determinants namely political stability and quality of infrastructure (Thomas, et al., 2005; Wint and Williams, 2002; Wijeweera and Mounter, 2008). A positive interest rate differential assists in attracting FDI inows as MNCs have incentive to invest in foreign country with positive interest rate differential and thus earn relatively more, subject to the condition that it does not get neutralized by foreign exchange movements. The World Investment Prospects Survey 2007-2009 suggests several reasons for rms to enter a particular market. They are classied into three categories: market-related factors, resource-related factors and seeking efciency. A major deterrent to FDI inow can be nancial instability in the host countrys economy, as any form of instability introduces a form of uncertainty that distorts the investors perception on the future protability in the country. Akinboade, et al. (2006) state that:
[. . .] low ination is taken to be a sign of internal economic stability in the host country. High ination indicates the inability of the government to balance its budget and the failure of the central bank to conduct appropriate monetary policy.

In other words, ination can be used as an indicator of the economic and political condition of the host country, but the differences between high ination and low ination are not distinct. Rogoff and Reinhart (2002) nd that high ination does not happened in the absence of other macroeconomic problems. The cost of ination can have prominent effect on the economys growth and this is more prominent at an ination rate at 40 percent and higher. However, they also note that a country with higher ination rate, especially below the 40 percent level, is worse off than a country with slightly lower ination. Hyperination has been dened as, ination so rapid that money ceases to be useful as a medium of exchange and a store of value. But scholars also concede that countries with ination rate higher than 50 percent, including up to 200 percent plus ination, have proven to be manageable as the population adjusts in real term. These studies have highlighted that ination destroys the value of currency as the impact on growth is negative, and in turn there is resultant negative impact on FDI. Few studies have suggested that high ination can cause various problems within the country to reduce its attractiveness to foreign investors. For instance, Coskun (2001) and De Wet (2003) suggest that lower ination and interest rate coupled with other factors such as full membership with the EU and high economic growth can attract foreign investors and increase the FDI inow into Turkey. Wint and Williams (2002) show that a stable economy attracts more FDI, thus a low ination environment is desired in countries that promote FDI as a source of capital ow. The relationships between FDI and a countrys money growth are still a subject of great debate. Several attempts have been made but there is still not any conclusive evidence of a strong relationship between the FDI attracted by a country and the money

growth in the country. However, Ali and Guo (2005) Determinant of FDI in China and Chowdhury and Mavrotas (2006) FDI and growth: what causes what? suggest that there is a moderately strong relationship between the two. A lot of research has pointed out the role of advancement in technology, patents held and research orientation as a great force to pull FDI in a country. Palit and Nawanis (2007) paper Technological capability as a determinant of FDI inows: evidence from developing Asia & India presents a strong case for a positive relationship between the two. They suggest two key determinants of FDI inows to developing Asian countries as R&D capacity to innovate and the ability to apply this capacity using latest IT techniques. For developing country like India, the signicance of these determinants is exemplied by the fact that more technology intensive sectors receive greater FDI. The ndings also shows that once initial advantages, like cheap labor and raw material cost vanishes, liberal policies alone are not enough for drawing FDI, if not backed by strong technological base and adequately developed infrastructure in sectors such as communications. Thus, policies should be aimed at more than just broad-based opening up of sectors and increasing the limit of such investment in these sectors, for sustained inows of FDI. Studies done in India There have not been too many studies conducted in India. Jha (2003) mentions that Indias competitive edge needs to be sharpened and it can be done by being more open under WTO and open door for more imports and exports under trade agreements. India is losing on M&A due to lacking in required IT and RnD and thus stressing upon the need for better research and development capabilities. But it states that one should be wary of equating FDI inows in India with the economic progress as situation is quite different here than compared to China or other developing nations. IV. Research design Objectives To nd the factors that determine FDI inow in India. For the purpose our dependant variable is Adjusted FDI inow in India. The FDI inow will be adjusted using GDP deator to take out the effect of ination and other anomalies as decided by government. The unit of the data is $ million. The variables that we have selected are: . Adjusted GDP of India. The GDP will be adjusted using GDP deator to take out the effect of ination and other anomalies as decided by government. The unit of data is $ million. . Ination. Using consumer price index data of India. The units are annual percent change. . Openness. The sum total of imports and exports data has been used as percentage of GDP to signify the openness of the economy. The units are percent of GDP. . Money Growth. The quasi money growth has been taken as proxy for the money growth. The units are annual percent change. . RnD. This is research and development which has been substituted by the patent application number from India. The units of the data in number.

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JITLP 10,1

Interest Rate. The nominal interest rate has been adjusted for ination to get real interest rate. The units are in percent.

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Sample selection There are various sources from where the data can be sourced. The selection of data is based upon the trust worthiness of the source and usability of the data. The data in Table I with mentioned frequency could be found at the checked sources. We have selected data from World Bank Database as it is standard and is used in most of the research studies. The data used has been presented in Appendix. Time period The time period selected is from 1991 to 2008 as India experiences structural break in and around 1990-1991 due to opening up of Indian economy and India bracing up for LPG as mentioned in Literature Review. Using data prior to 1990-1991 with later data will result in spurious results and thus incorrect model. Methodology The econometric model that we plan to study is: AFDI f AGDP; Openness; Inflation; Interest Rate; Money Growth; RnD where: AFDI AGDP Openness Ination Interest Rate Money Growth RnD Foreign direct investment adjusted for GDP deator (unit $ million) GDP adjusted for deator (unit $ million) Sum of imports and exports as percentage of GDP (percent) Ination rate calculated as percentage change in CPI (percent) Real interest rate (percent) Quasi money growth (percent) Patents application led (in number)

The reason for selection of these variables can be derived from the literature review as mentioned below in brief: . AGDP. Gross domestic product signies the economys output per year. It is expected that if an economys output is increasing in size then it should attract FDIs as the foreign investors will like to be part of the growth story. This of course, is dependent on the law and regulations, which is if FDI inows are allowed in the sectors of the economy that are seeing increase. But given no restriction to FDI inows, there is bound to be a relationship with increased/decreased GDP and correspondingly FDI inows. . Openness. Openness as dened by the total sum of exports and imports and thus signies the foreign trade by the country. It is expected that more the trade

Source NA Monthly and yearly Monthly Monthly Yearly Yearly

Data available

Data frequency

www.indiastat.com/membership.aspx http://mospi.nic.in

http://nmin.nic.in/

All paid membership MOSPI Statistics: covers price statistics, industrial statistics and social statistics done by the Central Survey Organization Monthly Economic Report, National summary data and economic survey

www.imf.org/external/country/IND/index.htm

www.imfstatistics.org/imf

Yearly

www.principalglobalindicators.org/

Yearly

http://data.worldbank.org

World Economic Outlook (WEO) databases: it has downloadable time series data available for GDP growth, ination rate, unemployment rate, balances of payments, exports and imports, external debt record, capital ows, etc. International Financial Statistics (IFS): it contains around 32,000 time series data available for India from 1948 onwards. Some of the series are exchange rates, fund accounts and other global and country economic indicators Principal Global Indicators (PGI): it contains data for the major economies including India from different international agencies covering the nancial, governmental, etc. and provides links to data in websites of international and national agencies It provides access to around 2,000 indicators from World Bank data sources Yearly

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Table I. Available data source

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.

72
.

allowed and/or available with a country, the more opportunities it brings for the investors and increased incentive for foreign investors to invest in the country. Ination. Ination rate affects FDI in terms of capital preservation. It is both internal and external factor. If an investor is looking to invest in the country then he would like to invest where the ination is low and/or corresponding to the returns that is the returns should be high above the ination rate to get net prots/returns. And so higher ination rates with not correspondingly higher returns will switch off investor and can lead to loss of FDI. Interest Rate. Real interest rate, that is interest rate after adjusting for ination is good measure and affecting variable for FDI inow in any country. The reason being that an investor will look for cheaper funding options as well as higher returns on the money invested in other country. This simply means that if the interest rates that can be earned are higher and the interest rate at which the funds can be borrowed in other country is relatively lower will attract FDI inow to the country. Money Growth. Money growth in an economy simply suggest the growth in the money availability and so the opportunities and growth of the nancial system. Usually, increase in nancial systems with stability helps attracting FDI inows as it increases the condence of the foreign investors on the countrys nancial structure. RnD. This variable is indirect representation of the scientic progress of a country. The foreign investors will like to make use of the scientic progress and the technology available in a particular country that is not available in its own country and so helps in attracting inows. Steps taken. We have one dependant and six independent time series. Besides, that we plan to employ dummy variables too to take care of the effects of policy changes in various years related to FDI that might have affected FDI inows to large-scale. The value of dummy variable is taken 0 for years before the policy were implemented and 1 after the policy was implemented.

Before we apply autoregressive integrated moving average (ARIMA), there are some assumptions that should be satised by our dependant and independent variables namely: . Variance. We have taken log of the time series in order to shorten the variance in the data over the years and thus restrict the data to a small range. Small variance is required for correct and consistent results of the regression modeling. For, e.g. the time series AFDI (Adjusted FDI) is now Log(AFDI). . Stationarity. We checked the time series (dependant as well as independent) for the stationarity. We used ADF Test (Augmented Dickey-Fuller) to test for stationarity. . Autocorrelation. In time series the residuals are found to be correlated with their own lagged values. This serial correlation violates the standard assumption of regression theory that disturbances are not correlated with other disturbances. We will apply Langrange Multiplier (LM) test, also known as Breusch-Godfrey (BG) test to test for serial correlation. . Multicollinearity. The independent variables should not have high correlation among them and should be unique to the extent that each one can be counted as separate and so we will check for the correlation among the independent variables.

Casualty. In economics data, it can happen that the relationship is both directions, that is dependant and independent variables affects each other and in that case we should not use regression model but vector models. We will use Granger casualty test to test for same. Heteroscedasticity. We will test for heteroscedasticity using Whites test.

Determinants of FDI in India

After this, we started making our model by taking dependant and all the independent terms and adjust the model for AR and MA terms in order to get the best model. The models can be checked and evaluated by using F-statistics, AIC and SIC and adjusted R 2 values. The F-statistics should be signicant enough to reject the null hypothesis that there is no model possible. The value of AIC (Akaine Information Criterion) and SC (Schwarz Criterion) should be minimum possible and value of adjusted R 2 should be maximum possible: . ARIMA. Autoregressive integrated moving average (ARIMA) models are generalizations of the simple AR model. We plan to use this model to nd the regression line and thus presence of relationship, if any. ARIMA uses three tools for modeling the serial correlation in the disturbance. . The rst tool is the autoregressive or AR term. The AR(1) model uses the rst-order term but any higher-order AR terms can be used according to the requirement. Each AR term corresponds to the use of a lagged value of the residual in the forecasting equation for the unconditional residual and the lag is denoted by the number in parenthesis. An autoregressive model of order p, AR( p) has the form: ut r1 ut21 r2 ut22 rp ut2p 1t
.

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The second tool is the integration order or I(d) term. Each integration order corresponds to differencing the time series. A rst-order integrated series, I(1) means that the econometric model has been designed using the rst difference of the original time series. Similarly a second-order component, I(2) corresponds to using second differences, and so on. The third tool is the moving average or MA term. A moving average model uses lagged values of the forecast error to improve the current forecast. A rst-order moving average, MA(1) term uses the most recent forecast error, a second-order term, MA(2), uses the forecast error from the two most recent periods, and so on. An MA (q) has the form: ut 1t u1 1t21 u2 1t22 uq 1t2q

The autoregressive and moving average specications can be combined to form an ARMA( p, q) specication: ut r1 ut21 r2 ut22 rp ut2p 1t u1 1t21 u2 1t22 uq 1t2q Although econometricians typically use ARIMA (p,d,q) models applied to the residuals from a regression model, the specication can also be applied directly to a series. This latter approach provides a univariate model, specifying the conditional mean of the series as a constant, and measuring the residuals as differences of the series from its mean. We plan to use lag of zero and apply ARMA (p,q) to our variables to nd any relationship.

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Limitations of the study . The major limitation can come in terms of trends and intercepts, is present in the time series data that we have. As we are taking time series data which pertains to economy and so the effect of recessions and other disturbances are bound to be present. These disturbances can lead to period of opposite or unexplained relationships and can distort the nal results. In our case as we are trying to nd the relationship between FDI and other independent variables and as FDI itself should also gets affected in same direction as the independent variables, in case of recession like disturbances and so we expect the effect should be minimized. . The economy per say always has a cyclic tendency. This again has scope for distorting the nal result and as again the reason given above we think that the effect will be minimized. . We have tried to nd factors that might be contributing to the FDI inows in India but as it varies for each country and so the list cannot be exhaustive and so we have to nd how much change our independent variables are able to account for and how much is still left to be explained. . As we are using specic statistical methods to verify our model and so the basic limitations of the statistical methods used will apply to our model also. For, e.g. in regression, we use least square method to nd the best t but it does not guarantees the tight t. The R 2 measures the amount of the tightness presented by the model we get in the end and if it is less than 100 percent, which is more often is the case, then the model predicted will not be able to forecast with full condence and there will be error component as well as unexplained deviations. V. Analysis and ndings Stationarity test Using ADF method, the results are shown Table II: H 0.
Variable Log(AFDI) Log(AGDP) Log(Openness) Log(Ination Index) Log(RnD) Log(Interest Rate) Log(Money Growth) D(Log(AFDI)) D(Log(AGDP)) D(Log(Openness)) D(Log(Ination Index)) D(Log(RnD)) D(Log(Interest Rate)) D(Log(Money Growth))

The variable has a unit root.

ADF(c,t,p) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) ADF(0,0,0) t-statistics 2.554042 1.318522 6.490412 2 0.798257 4.378330 2 0.010207 2 0.055699 2 3.105106 2 3.411063 2 1.714795 2 5.237164 2 2.053572 2 7.099597 2 7.836622 Prob. 0.9952 0.9458 1.0000 0.3553 0.9999 0.6653 0.6499 0.0042 * 0.0021 * 0.0815 * * 0.0000 * 0.0417 * 0.0000 * 0.0000 *

Table II. ADF test results

Note: Signicance at: *5 and * *10 percent levels

All the series (after taking log) are found to be stationary after rst difference and thus any further testing will be done with difference of the log of the series. For instance, Log (FDI) is now D(log(FDI)). Autocorrelation test Using LM test/BG test, the results are shown in Table III: H0. No serial correlation in the residuals up to the specied order.

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We found no evidence to reject the null hypothesis, which is that there is no serial correlation up to lag order three. Thus, all the independent variables can be used for the model. Multi-colinearity Correlation test results are shown in Table IV. As seen in Table IV, we found low correlation among independent variables and so all of them can be used for the model. Casualty Granger casualty test results are shown in Table V. As seen in Table V, we found little evidence to reject Null hypothesis that our dependant variable Granger cause independent variables. Thus, we can use regression model. Heteroscedasticity White test results are shown in Table VI: H0. No Heteroscedasticity is present. Using Whites test without cross-terms and found no evidence to reject null hypothesis that is there is no heteroscedasticity present. Now we proceeded with ARIMA (p,d,q) modeling as mentioned before and the results obtained are shown in Table VII: H0. There is no relationship. We nd in our models that dummy variable for year 1995, 1996 and 1997 comes signicant individually with all other independent variables. In addition, the model with all the independent variables as signicant shows that only GDP, Ination rate
Variable (Lag 3) D(Log(AGDP)) D(Log(Openness)) D(Log(Ination Index)) D(Log(RnD)) D(Log(Interest Rate)) D(Log(Money Growth)) F-statistic Obs. *R 2 Coefcient 2 0.597772 0.311355 2 0.346249 1.390249 0.127370 2 0.033260 0.175798 1.191073 SE 2.000331 2.164254 0.671384 3.012940 0.474876 0.557319 Prob. F(1,9) Prob. x2(1) t-statistic 2 0.298837 0.143862 2 0.515724 0.461426 0.268218 2 0.059678 0.9094 0.7551 Prob. 0.7737 0.8897 0.6219 0.6585 0.7963 0.9541 Table III. LM/BG test results

Note: Signicant at: *10 percent level

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D(Log(AGDP)) D(Log(Openness)) D(Log(Ination Index)) D(Log(RnD)) D(Log(Interest Rate)) D(Log(Money Growth))

Table IV. Correlation test results D(Log(Openness)) 20.220184 1.000000 0.143137 20.134634 20.198913 20.145764 20.011822 0.143137 1.000000 0.604258 20.336234 0.177566 0.451159 20.134634 0.604258 1.000000 20.475887 0.344401 20.246584 20.198913 20.336234 20.475887 1.000000 20.240411 D(Log(Ination Index)) D(Log(RnD)) D(Log(Interest Rate)) D(Log(Money Growth)) 0.132262 2 0.145764 0.177566 0.344401 2 0.240411 1.000000

D(Log(AGDP))

1.000000 2 0.220184 2 0.011822 0.451159 2 0.246584 0.132262

Null hypothesis D(Log(AGDP)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D(Log(AGDP)) D(Log(Openness)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D(Log(Openness)) D(Log(Ination Index)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D(Log(Ination Index)) D(Log(RnD)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D(Log(RnD)) D(Log(Interest Rate)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D D(Log(Interest Rate)) D(Log(Money Growth)) does not Granger cause D(Log(AFDI)) D(Log(AFDI)) does not Granger cause D(Log(Money Growth)) Note: Signicant at: * *10 percent level

Obs. 15 15 15 15 15 15

F-statistic 2.09750 0.20977 9.85970 0.95886 0.28038 2.70454 0.03065 0.42504 0.59990 0.68484 0.03325 0.24867

Prob. 0.1735 0.8143 0.0043 0.4159 0.7612 0.1151 0.9699 0.6650 0.5675 0.5263 0.9674 0.7845

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Table V. Granger casualty test results

Variable D(Log(AGDP))^2 D(Log(Openness)) ^2 D(Log(Ination Index)) ^2 D(Log(RnD)) ^2 D(Log(Interest Rate)) ^2 D(Log(Money Growth)) ^2

Coefcient 2 2.784472 2 0.581362 0.208512 1.445589 0.121883 2 0.118605

SE 4.261811 2.444435 0.166475 1.993413 0.250783 0.401881

t-statistic 2 0.653354 2 0.237831 1.252512 0.725183 0.486010 2 0.295124

Prob. 0.5283 0.8168 0.2389 0.4850 0.6374 0.7739

Note: Signicance at: *5 and * *10 percent levels

Table VI. White test results

and patents along with affect of 1995 policy can explain 63 percent of the variations in FDI and other independent variables are insignicant. VI. Summary and recommendations We tried to nd the factors determining FDI inow in India. We collected independent variables such as adjusted GDP, ination rate, real interest rate, patents, money growth and trade statistics, which have been attributed as determining factors for difference of FDI inow in any country in various research reports and literature. We started with an assumption that there is no relationship and no variance in difference of FDI inow can be explained by any of these factors. We tested for various assumptions that are taken before applying ARIMA model and found all of them to be satised. Later we tried to nd the best model by changing p AR terms, d Lag term and q MA terms and found the best model which is able to explain 63 percent of the variation in the FDI Inows. Also we found out that GDP, ination and scientic research are signicant in explaining the variance in FDI Inows. We also found that policy changes in years 1995 and later 1996 and 1997 has had important impact on the FDI Inow into India and may be proved to be the turning point in taking India to the place it is now. VII. Scope for further research The further work that should be done is to nd out other independent variables that can be used to dene the 37 percent remaining variation in the FDI Inows. FDI Inows

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D(log(AFDI) 2.492 (2.66) * 1.036 (3.711) * 24.064 (23.173) * 2.975 20.127 0.829 24.336 20.231 0.400 (2.662) * (2 0.0848) (2.773) * (2 2.611) * (2 0.531) (0.879) 3.397 (2.772) * 2 0.105 (20.067) 0.882 (2.875) * 2 4.82 (22.871) * 2 0.439 (20.998) 0.191 (0.406)

D(log(AGDP) D(log(Openness)) D(log(Ination Index) D(log(RnD) D(log(Interest Rate)) D(log(Money growth) D1 (1992) D2 (1993) D3 (1994) D4 (1995) D5 (1996) D6 (1997) D7 (1998) D8 (1999) D9 (2000) D10 (2001) D11 (2002) D12 (2003) D13 (2004) D14 (2005) D15 (2006) D16 (2007) AR(1) AR(2) MA(1) MA(2) R2 R 2 adjusted F-statistics 20.144 (2 2.542) * 2 0.104 (22.315) * 20.286 (24.405) * 20.980 (2 22.68) * 0.81 0.62 4.266 * 2 0.985 (224.52) * 0.79 0.58 3.869 * 20.999 (26.314) * 0.75 0.63 6.636 * 0.803 0.606 4.081 *

Note: Signicance at: *5 and * *10 percent levels

Table VII. ARIMA model results Model 1 Model 2 Model 3 Model 4

2.411 (2.178) * * 0.592 (0.397) 0.892 (2.95) * 2 3.793(22.206) * * 0.1511 (0.303) 0.227 (0.489)

2 0.215 (22.522) *

2 0.999 (27.628) *

can be affected by a range of factors and so it will be useful if an exhaustive list can be prepared and a report can be prepared to explain up to 99 percent variation in the FDI inow sector wise for India. Some of the variables that can be used are exchange rate and trade strikes. Exchange rate is a signicant factor and affects the inows/outows to a great extent. Why it is important is because the relative exchange rate ensures the use and importance of the ow and value of money and so act as the incentive for investing abroad. Trade strikes will give an idea about the industrial situation and the relative volatility which will help investors to decide if their investments are safe and will be able to give higher returns. Policy framework The variables that we have found to be important measure of expected FDI are adjusted GDP, ination rate and RnD (patents). Similarly the variables that we have found to be not signicant are Openness, money growth and real interest rate. This clearly shows that if given a chance the variables that should be improved by the government or other decision taking agencies should be GDP growth, ination and scientic research. According to the relation that we have got by applying ARIMA model, it is apparent that GDP growth and ination positively impacts the inow of FDI in the country. But the growth in scientic growth impacts negatively, which is surprising. As suggestions for policy implementations, we will like to suggest that government should give resources towards GDP growth and ination and so should open the economy even more. There should be stress on opening various sectors which are not open to FDI investments as yet, such as defense, etc. and should try to give investors condence as FDI inows is always good for any economy. Ination though should be controlled but some ination is good for FDI Inows and so should be maintained at threshold level as applicable for India.
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Ernst & Young (2010), Ernst and Youngs 2010 European Attractiveness Survey, available at: http://.ey.com/GL/en/Issues/Business-environment/2010-Europeanattractiveness-survey Fedderke, J.W. and Romm, A. (2006), Growth impact and determinants of foreign direct investment into South Africa, 1956-2003, Economic Modeling, Vol. 23 No. 5, pp. 738-60. Jenkins, C. and Thomas, L. (2002), Foreign direct investment in Southern Africa: determinants, characteristics and implications for economic growth and poverty alleviation, University of Oxford, Oxford, available at: http://csae.ox.ac.uk/reports/pdfs/rep2002-02.pdf Jha, R. (2003), Recent Trends in FDI Flows and Prospects for India, Australian National University (ANU), Australia South Asia Research Centre (ASARC), Canberra. Moran, T.H., Graham, E.D. and Blomstrom, M. (2005), Does Foreign Direct Investment Promote Development?, Institute for International Economics/Center for Global Development, Washington, DC, p. 411. Nonnemberg, M.B. and Cardoso De Mendonca, M.J. (2004), The determinants of foreign direct investment in developing countries, Proceedings of the 32th Brazilian Economics Meeting, Brazil. Nwankwo, A. (2006), The determinants of foreign direct investment inows (FDI) in Nigeria, paper presented at 6th Global Conference on Business & Economics, Gutman Conference Centre, Cambridge, October 15-17. Odenthal, L. and Zimmy, Z. (1999), Foreign Direct Investment in Africa: Performance and Potential, UNCTAD, Geneva. Palit, A. and Nawani, S. (2007), Technological capability as a determinant of FDI inows: evidence from developing Asia & India, Working Paper No. 193, Indian Council for Research on International Economic Relations, New Delhi. Rogoff, K. and Reinhart, C. (2002), FDI to Africa: the role of price stability and currency instability, paper presented at The Annual World Bank Conference on Development Economics, Washington DC, April 29-30. Seetanah, B. and Khadaroo, A.J. (2007), Foreign direct investment and growth: new evidences from Sub-Saharan African countries, paper presented at Economic Development in Africa 2007, CSAE Conference. Thomas, L., Leape, J. with Hanouch, M. and Rumney, R., Business Map Foundation (2005), Foreign Direct Investment in South Africa: The Initial Impact of the Trade, Development and Cooperation Agreement between South Africa and the European Union, CREFSA, London School of Economics, available at: http://lse.ac.uk/Depts/CREFSA/pdf/CREFSA_ BusinessMap_FDI_in_South_Africa_October_2005.pdf Wijeweera, A. and Mounter, S. (2008), A VAR analysis on the determinants of FDI inows: the case of Sri Lanka, Applied Econometrics and International Development, Vol. 8 No. 1, pp. 189-98. Wint, G.W. and Williams, D.A. (2002), Attracting FDI to developing countries: a changing role for government?, International Journal of Public Sector Management, Vol. 15 No. 5, pp. 361-74. Yang, J.Y.Y., Groenewold, N. and Tcha, M. (2000), The determinants of foreign direct investment in Australia, The Economic Record, Vol. 76 No. 232, pp. 45-54.

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About the authors Monica Singhania is Associate Professor, Faculty of Management Studies (FMS), University of Delhi. She is a graduate from Shri Ram College of Commerce, post-graduate from Delhi School of Economics and a Fellow Member (FCA) of the Institute of Chartered Accountants of India. She has the distinction of being placed in the merit list of the examinations conducted by both the University as well as the Institute. She has been awarded PhD in the area of corporate nance and taxation from the University of Delhi. She is the author of seven books on direct tax laws and several research papers published in leading journals. She teaches management accounting, management control systems, project management and corporate taxation to MBA students at FMS. Monica Singhania is the corresponding author and can be contacted at: monica@fms.edu Akshay Gupta belongs to the MBA Class of 2011, Faculty of Management Studies (FMS), University of Delhi. He is also Bachelor of Engineering (with distinction and merit) from Delhi College of Engineering, University of Delhi. Prior to joining FMS, he has worked as Software Engineer with Cisco Systems and as an Intern with various organizations such as Deutsche Bank, Mentor Graphics, Defense Research and Development Organization (DRDO) and Central Electronics Engineering Research Institute (CEERI). His interest lies in quantitative nance, equity research and portfolio management.

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Indicator_ Name 492,915.2519 415,173.5141 425,028.4548 452,832.6104 457,238.3093 463,392.0096 460,579.6345 432,071.8031 450,476.1993 444,508.4099 448,011.0878 458,130.025 522,882.3371 579,008.5128 642,598.001 691,297.8886 847,826.4174 786,195.8179 9.325931366 11.02685592 12.91298702 14.51065563 18.02513709 18.59386749 20.41998323 23.10683746 25.27613491 28.34717907 28.16591393 33.17512609 35.42644028 45.93258842 53.62334276 62.79002535 63.69109264 74.74805544 13.8702461 11.78781925 6.362038664 10.21150033 10.22488756 8.977149075 7.16425362 13.2308409 4.669821024 4.009433962 3.684807256 4.392199745 3.805865922 3.76723848 4.246353323 5.799385426 6.369996746 8.351816444 1,267 1,248 1,209 1,588 1,545 1,661 1,926 2,247 2,206 2,179 2,371 2,693 3,425 4,014 4,521 5,314 6,000 6,500 3.643792 9.1230537 5.866608 4.3176331 5.8517736 7.8216536 6.9276375 5.1481985 8.4212005 8.467056 8.7899864 7.8238091 7.6309535 5.0437235 6.3410241 5.9200689 7.7541577 6.6817551 18.31695 16.862495 17.007663 20.277728 11.011121 18.736274 17.656754 18.173015 17.14918 15.171708 14.320551 16.761165 13.033611 16.732333 15.599904 21.633141 22.271503 20.49521

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: World Bank Databank, available at: http://data.worldbank.org/country/india (accessed July 20, 2010)

Table AI.

Appendix
Money and quasi money growth (annual %)

AFDI, net inows (in million $) AGDP (current Trade of goods and million US$) services (% of GDP) Ination, consumer prices (annual %)

Patent applications, residents

Real interest rate (%)

135.49398 467.51846 847.43209 1,362.3514 2,750.9168 2,894.8965 4,009.6971 2,734.7796 2,168.5911 3,462.1403 5,130.2686 5,081.8389 3,770.5321 4,767.4867 6,033.2839 15,365.966 18,101.489 27,922.189