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JITLP
10,1 Determinants of foreign direct
investment in India
Monica Singhania and Akshay Gupta
64 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, inflation rate, interest
rate, patents, money growth and foreign trade – the authors tried to find the best fit model (ARIMA
(p,d,q)) to explain variation in FDI inflows 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 quantified FDI policy changes using dummy variables.
Findings – It was found that of all macroeconomic variables taken, only GDP, inflation rate and
scientific research are significant and that FDI Policy changes during years 1995-1997 have had a
significant impact on FDI inflows into India.
Research limitations/implications – The authors’ econometric model explains 63 percent
variation in FDI inflows into India. Implicitly, the balance 37 percent variation in FDI inflows 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 classified
as significant in this paper, namely GDP growth and inflation rate and should open the economy further.
Sectors not yet open to FDI investments should be opened and although inflation rate should be
controlled but some inflation is beneficial.
Originality/value – There has been no authoritative study until now to find “Determinants of FDI
inflow to India” and this paper also goes a step forward and presents accurate models that can be used to
forecast FDI inflows based on the macroeconomic variables considered.
Keywords India, International investments, Macroeconomics
Paper type Research paper

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
inflow 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 beneficial inter-linkage with them.
In a way, the major structural changes under the economic liberalization program Determinants
continued till 1995. As India moved from policies of import substitution to export of FDI in India
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 financial systems, lower wages and production costs, low inflation
rate and increasingly reformed exchange rate system, etc. These factors ensured that 65
India continued to attract an increasingly large chunk of FDI and as of now, India has
become the second favorite destination for FDI inflows for next three years (Ernst &
Young, 2010). Figure 1 shows FDI inflow 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 first set of theories analyse FDI in the context of
portfolio allocation framework and second set of theories analyse FDI flow in the context
of market imperfections.
According to portfolio allocation framework FDI flow depends on factors such as
international differences in profit ratios, interest rates and/or other measure of return to
investment. Market imperfections-based theories states that FDI flow 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 flows.

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 ¼f ðAGDP ; Openness; Inflation; Interest Rate; Money Growth;

Scientific ProgressÞ

FDI in flow in India

30,000

25,000

20,000
In $ million

15,000

10,000

5,000

0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Year Figure 1.
Adjusted FDI Inflow
Source: World Bank Databank, http://data.worldbank.org/country/india
JITLP where:
10,1 AFDI ¼ Foreign direct investment adjusted for GDP deflator (unit
million).
AGDP ¼ GDP adjusted for deflator (unit $ million).
Openness ¼ Sum total of imports and exports as percentage of GDP
66 (percent).
Inflation ¼ Inflation rate calculated as percentage change in Consumer
Price Index (CPI) (percent).
Interest Rate ¼ Real interest rate (percent).
Money Growth ¼ Quasi money growth (percent).
Scientific Progress ¼ Patents application filed (in number).
There are several studies and literature to signify the importance of each of the selected
independent variables in determining the inflow 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 inflation rate decides the final value of the returns of the investment on the money
invested in the country and so is again an important determinant of the FDI inflows.
Real interest rate signifies further source of money and relatively stable and low
interest rate helps in better financing of the projects along with FDI money. At the
same time, the scientific 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 inflows using the defined 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 inflows as given. This
analysis will enable companies to predict, if possible, the probability of FDI inflows
(in case allowed in their respective sectors) and in this way look for this alternate
important source of project financing.

III. Literature review

Studies done abroad
There have been numerous studies done for determinants of FDI inflows for various
countries. This literature review draws from past studies and provides an explorative
view of the relationship that FDI inflows have with its determinants.
As far as the relationship between FDI and a country’s 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 Determinants
provided by FDI through the spillover effect. However, the capacity of the host country to of FDI in India
absorb these resources and generate growth successfully depends upon its policies.
World Bank defines 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 country’s
economic growth, Moran, et al. (2005) have concluded that the effect of FDI on the host 67
country’s growth depends to a great extent on the host country’s economic openness.
The more liberalized the economy, the more likely the positive benefits 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 Mendonça (2004) however find that while
strong GDP growth can induce FDI inflow, 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 China’s 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 significant in the final model of the study.
Carkovic and Levine (2002) find that FDI does not induce economic growth
independently. Microeconomic conditions of the country such as the host country’s
specific 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) finds that the impact of FDI on growth varies across sectors.
The benefit depends on the “spillover potential” of the industry. Other studies also
highlight the fact that the benefits of FDI on growth cannot be generalized across
different countries or sectors. Each market has certain specific conditions that could
enhance or hinder these benefits on the host country’s 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 benefits from the spillover of technologies and skills, but also the fact
that FDI is a highly resilient form of capital flow for the host country. Investments via
FDI are less likely to be withdrawn during financial crisis when compared to other forms
of foreign financing such as portfolio investment.
The host country economy’s 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
JITLP for FDI as a channel to bypass trade barriers. On the other hand, a relatively closed
10,1 capital account, for, e.g. restricted foreign ownership, may lead to discouraged FDI
flows. A significant empirical research in related field has provided convincing evidence
that FDI is a significant 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 influence FDI
68 inflow into a host country. These include economic factors such as the target country’s
market size, income level, market growth rate, inflation 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 inflows 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 firms
to enter a particular market. They are classified into three categories: market-related
factors, resource-related factors and seeking efficiency. A major deterrent to FDI inflow
can be financial instability in the host country’s economy, as any form of instability
introduces a form of uncertainty that distorts the investors’ perception on the future
profitability in the country.
Akinboade, et al. (2006) state that:
[. . .] low inflation is taken to be a sign of internal economic stability in the host country. High
inflation 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, inflation can be used as an indicator of the economic and political condition
of the host country, but the differences between “high” inflation and “low” inflation are not
distinct. Rogoff and Reinhart (2002) find that high inflation does not happened in the
absence of other macroeconomic problems. The cost of inflation can have prominent effect
on the economy’s growth and this is more prominent at an inflation rate at 40 percent and
higher. However, they also note that a country with higher inflation rate, especially below
the 40 percent level, is worse off than a country with slightly lower inflation. Hyperinflation
has been defined as, “inflation 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 inflation rate
higher than 50 percent, including up to 200 percent plus inflation, have proven to be
manageable as the population adjusts in “real term”. These studies have highlighted that
inflation 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 inflation
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 inflation 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 inflow into Turkey.
Wint and Williams (2002) show that a stable economy attracts more FDI, thus a low
inflation environment is desired in countries that promote FDI as a source of capital flow.
The relationships between FDI and a country’s 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 Determinants
Chowdhury and Mavrotas (2006) “FDI and growth: what causes what?” suggest that of FDI in India
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 Nawani’s
(2007) paper “Technological capability as a determinant of FDI inflows: evidence from
developing Asia & India” presents a strong case for a positive relationship between the 69
two. They suggest two key determinants of FDI inflows 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 significance of these determinants is
exemplified by the fact that more technology intensive sectors receive greater FDI. The
findings 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
inflows of FDI.

Studies done in India

There have not been too many studies conducted in India. Jha (2003) mentions that
India’s 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 inflows 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 find the factors that determine FDI inflow in India.
For the purpose our dependant variable is “Adjusted FDI inflow in India”. The FDI
inflow will be adjusted using GDP deflator to take out the effect of inflation 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 deflator to take out
the effect of inflation and other anomalies as decided by government. The unit of
data is $ million.
.
Inflation. 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.
JITLP .
Interest Rate. The nominal interest rate has been adjusted for inflation to get real
10,1 interest rate. The units are in percent.

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.
70 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 ¼ f ðAGDP; Openness; Inflation; Interest Rate; Money Growth; RnDÞ

where:
AFDI ¼ Foreign direct investment adjusted for GDP deflator (unit
$ million)
AGDP ¼ GDP adjusted for deflator (unit $ million)
Openness ¼ Sum of imports and exports as percentage of GDP (percent)
Inflation ¼ Inflation rate calculated as percentage change in CPI (percent)
Interest Rate ¼ Real interest rate (percent)
Money Growth ¼ Quasi money growth (percent)
RnD ¼ Patents application filed (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 signifies the economy’s output per year. It is
expected that if an economy’s 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 inflows are allowed in the
sectors of the economy that are seeing increase. But given no restriction to FDI
inflows, there is bound to be a relationship with increased/decreased GDP and
correspondingly FDI inflows.
.
Openness. Openness as defined by the total sum of exports and imports and thus
signifies the foreign trade by the country. It is expected that more the trade
Source
www.indiastat.com/membership.aspx
http://mospi.nic.in
http://finmin.nic.in/
www.imf.org/external/country/IND/index.htm
www.imfstatistics.org/imf
www.principalglobalindicators.org/
http://data.worldbank.org
Available data source
Table I.
Data available Data frequency
All paid membership NA
MOSPI Statistics: covers price statistics, industrial Monthly and yearly
statistics and social statistics done by the Central
Survey Organization
Monthly Economic Report, National summary data Monthly
and economic survey Monthly
Yearly
World Economic Outlook (WEO) databases: it has Yearly
downloadable time series data available for GDP
growth, inflation rate, unemployment rate, balances
of payments, exports and imports, external debt
record, capital flows, etc.
International Financial Statistics (IFS): it contains Yearly
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 Yearly
the major economies including India from different
international agencies covering the financial,
governmental, etc. and provides links to data in
websites of international and national agencies
It provides access to around 2,000 indicators from Yearly
World Bank data sources
Determinants
of FDI in India
71
JITLP allowed and/or available with a country, the more opportunities it brings for the
10,1 investors and increased incentive for foreign investors to invest in the country.
.
Inflation. Inflation 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 inflation is low and/or corresponding to the
returns that is the returns should be high above the inflation rate to get net
72 profits/returns. And so higher inflation 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 inflation is
good measure and affecting variable for FDI inflow 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 inflow 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 financial system.
Usually, increase in financial systems with stability helps attracting FDI inflows as it
increases the confidence of the foreign investors on the country’s financial structure.
.
RnD. This variable is indirect representation of the scientific progress of a
country. The foreign investors will like to make use of the scientific progress and
the technology available in a particular country that is not available in its own
country and so helps in attracting inflows.
.
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 inflows 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 satisfied 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 Determinants
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
of FDI in India
Granger casualty test to test for same.
.
Heteroscedasticity. We will test for heteroscedasticity using Whites test.

After this, we started making our model by taking dependant and all the independent 73
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 significant 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 find the
regression line and thus presence of relationship, if any. ARIMA uses three tools
for modeling the serial correlation in the disturbance.
.
The first tool is the autoregressive or AR term. The AR(1) model uses the first-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 ¼ r1 ut21 þ r2 ut22 þ · · · þ rp ut2p þ 1t

.
The second tool is the integration order or I(d) term. Each integration order
corresponds to differencing the time series. A first-order integrated series, I(1)
means that the econometric model has been designed using the first 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 first-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 ¼ 1t þ u1 1t21 þ u2 1t22 þ · · · þ uq 1t2q

The autoregressive and moving average specifications can be combined to form an

ARMA( p, q) specification:
ut ¼ r1 ut21 þ r2 ut22 þ · · · þ rp ut2p þ 1t þ u1 1t21 þ u2 1t22 þ · · · þ uq 1t2q
Although econometricians typically use ARIMA (p,d,q) models applied to the residuals
from a regression model, the specification 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 find any relationship.
JITLP Limitations of the study
10,1 .
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 final results. In our case as we are trying to find
74 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 final result and as again the reason given above we think that the
effect will be minimized.
.
We have tried to find factors that might be contributing to the FDI inflows in
India but as it varies for each country and so the list cannot be exhaustive and so
we have to find how much change our independent variables are able to account
for and how much is still left to be explained.
.
As we are using specific 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 find the best fit but it does not
guarantees the tight fit. 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 confidence
and there will be error component as well as unexplained deviations.

V. Analysis and findings

Stationarity test
Using ADF method, the results are shown Table II:
H 0. The variable has a unit root.

Variable ADF(c,t,p) t-statistics Prob.

Log(AFDI) ADF(0,0,0) 2.554042 0.9952

Log(AGDP) ADF(0,0,0) 1.318522 0.9458
Log(Openness) ADF(0,0,0) 6.490412 1.0000
Log(Inflation Index) ADF(0,0,0) 2 0.798257 0.3553
Log(RnD) ADF(0,0,0) 4.378330 0.9999
Log(Interest Rate) ADF(0,0,0) 2 0.010207 0.6653
Log(Money Growth) ADF(0,0,0) 2 0.055699 0.6499
D(Log(AFDI)) ADF(0,0,0) 2 3.105106 0.0042 *
D(Log(AGDP)) ADF(0,0,0) 2 3.411063 0.0021 *
D(Log(Openness)) ADF(0,0,0) 2 1.714795 0.0815 * *
D(Log(Inflation Index)) ADF(0,0,0) 2 5.237164 0.0000 *
D(Log(RnD)) ADF(0,0,0) 2 2.053572 0.0417 *
D(Log(Interest Rate)) ADF(0,0,0) 2 7.099597 0.0000 *
D(Log(Money Growth)) ADF(0,0,0) 2 7.836622 0.0000 *
Table II.
ADF test results Note: Significance at: *5 and * *10 percent levels
All the series (after taking log) are found to be stationary after first difference and thus Determinants
any further testing will be done with difference of the log of the series. For instance,
Log (FDI) is now D(log(FDI)).
of FDI in India

Autocorrelation test
Using LM test/BG test, the results are shown in Table III:
H0. No serial correlation in the residuals up to the specified order. 75
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 find in our models that dummy variable for year 1995, 1996 and 1997 comes
significant individually with all other independent variables. In addition, the model
with all the independent variables as significant shows that only GDP, Inflation rate

Variable (Lag 3) Coefficient SE t-statistic Prob.

D(Log(AGDP)) 2 0.597772 2.000331 2 0.298837 0.7737

D(Log(Openness)) 0.311355 2.164254 0.143862 0.8897
D(Log(Inflation Index)) 2 0.346249 0.671384 2 0.515724 0.6219
D(Log(RnD)) 1.390249 3.012940 0.461426 0.6585
D(Log(Interest Rate)) 0.127370 0.474876 0.268218 0.7963
D(Log(Money Growth)) 2 0.033260 0.557319 2 0.059678 0.9541
F-statistic 0.175798 Prob. F(1,9) 0.9094
Obs. *R 2 1.191073 Prob. x2(1) 0.7551
Table III.
Note: Significant at: *10 percent level LM/BG test results
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Table IV.
Correlation test results
D(Log(AGDP)) D(Log(Openness)) D(Log(Inflation Index)) D(Log(RnD)) D(Log(Interest Rate)) D(Log(Money Growth))

D(Log(AGDP)) 1.000000 20.220184 20.011822 0.451159 20.246584 0.132262

D(Log(Openness)) 2 0.220184 1.000000 0.143137 20.134634 20.198913 2 0.145764
D(Log(Inflation Index)) 2 0.011822 0.143137 1.000000 0.604258 20.336234 0.177566
D(Log(RnD)) 0.451159 20.134634 0.604258 1.000000 20.475887 0.344401
D(Log(Interest Rate)) 2 0.246584 20.198913 20.336234 20.475887 1.000000 2 0.240411
D(Log(Money Growth)) 0.132262 20.145764 0.177566 0.344401 20.240411 1.000000
 Determinants
Null hypothesis Obs. F-statistic Prob.
of FDI in India
D(Log(AGDP)) does not Granger cause D(Log(AFDI)) 15 2.09750 0.1735
D(Log(AFDI)) does not Granger cause D(Log(AGDP)) 0.20977 0.8143
D(Log(Openness)) does not Granger cause D(Log(AFDI)) 15 9.85970 0.0043
D(Log(AFDI)) does not Granger cause D(Log(Openness)) 0.95886 0.4159
D(Log(Inflation Index)) does not Granger cause D(Log(AFDI)) 15 0.28038 0.7612 77
D(Log(AFDI)) does not Granger cause D(Log(Inflation Index)) 2.70454 0.1151
D(Log(RnD)) does not Granger cause D(Log(AFDI)) 15 0.03065 0.9699
D(Log(AFDI)) does not Granger cause D(Log(RnD)) 0.42504 0.6650
D(Log(Interest Rate)) does not Granger cause D(Log(AFDI)) 15 0.59990 0.5675
D(Log(AFDI)) does not Granger cause D D(Log(Interest Rate)) 0.68484 0.5263
D(Log(Money Growth)) does not Granger cause D(Log(AFDI)) 15 0.03325 0.9674
D(Log(AFDI)) does not Granger cause D(Log(Money Growth)) 0.24867 0.7845 Table V.
Granger casualty test
Note: Significant at: * *10 percent level results

Variable Coefficient SE t-statistic Prob.

D(Log(AGDP))^2 2 2.784472 4.261811 2 0.653354 0.5283

D(Log(Openness)) ^2 2 0.581362 2.444435 2 0.237831 0.8168
D(Log(Inflation Index)) ^2 0.208512 0.166475 1.252512 0.2389
D(Log(RnD)) ^2 1.445589 1.993413 0.725183 0.4850
D(Log(Interest Rate)) ^2 0.121883 0.250783 0.486010 0.6374
D(Log(Money Growth)) ^2 2 0.118605 0.401881 2 0.295124 0.7739
Table VI.
Note: Significance at: *5 and * *10 percent levels 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 insignificant.

VI. Summary and recommendations

We tried to find the factors determining FDI inflow in India. We collected independent
variables such as adjusted GDP, inflation rate, real interest rate, patents, money growth
and trade statistics, which have been attributed as determining factors for difference of
FDI inflow 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 inflow 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 satisfied. Later we tried to find the best
model by changing “p” ¼ AR terms, “d” ¼ Lag term and “q” ¼ MA terms and found
the best model which is able to explain 63 percent of the variation in the FDI Inflows. Also
we found out that GDP, inflation and scientific research are significant in explaining the
variance in FDI Inflows. We also found that policy changes in years 1995 and later 1996
and 1997 has had important impact on the FDI Inflow 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 find out other independent variables that can
be used to define the 37 percent remaining variation in the FDI Inflows. FDI Inflows
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Table VII.
ARIMA model results
D(log(AFDI) Model 1 Model 2 Model 3 Model 4

D(log(AGDP) 2.411 (2.178) * * 2.975 (2.662) * 3.397 (2.772) * 2.492 (2.66) *

D(log(Openness)) 0.592 (0.397) 20.127 (2 0.0848) 2 0.105 (20.067)
D(log(Inflation Index) 0.892 (2.95) * 0.829 (2.773) * 0.882 (2.875) * 1.036 (3.711) *
D(log(RnD) 2 3.793(22.206) * * 24.336 (2 2.611) * 2 4.82 (22.871) * 24.064 (23.173) *
D(log(Interest Rate)) 0.1511 (0.303) 20.231 (2 0.531) 2 0.439 (20.998)
D(log(Money growth) 0.227 (0.489) 0.400 (0.879) 0.191 (0.406)
D1 (1992)
D2 (1993)
D3 (1994)
D4 (1995) 2 0.215 (22.522) * 20.286 (24.405) *
D5 (1996) 20.144 (2 2.542) *
D6 (1997) 2 0.104 (22.315) *
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) 2 0.999 (27.628) * 20.980 (2 22.68) * 2 0.985 (224.52) * 20.999 (26.314) *
MA(2)
R2 0.803 0.81 0.79 0.75
R 2 adjusted 0.606 0.62 0.58 0.63
F-statistics 4.081 * 4.266 * 3.869 * 6.636 *
Note: Significance at: *5 and * *10 percent levels
can be affected by a range of factors and so it will be useful if an exhaustive list can be Determinants
prepared and a report can be prepared to explain up to 99 percent variation in the FDI of FDI in India
inflow sector wise for India. Some of the variables that can be used are exchange rate and
trade strikes. Exchange rate is a significant factor and affects the inflows/outflows to a
great extent. Why it is important is because the relative exchange rate ensures the use
and importance of the flow 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 79
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, inflation rate and RnD (patents). Similarly the variables that we have found to be
not significant 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, inflation and scientific research.
According to the relation that we have got by applying ARIMA model, it is apparent that
GDP growth and inflation positively impacts the inflow of FDI in the country. But the
growth in scientific 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 inflation 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 confidence as FDI inflows
is always good for any economy. Inflation though should be controlled but some inflation
is good for FDI Inflows and so should be maintained at threshold level as applicable
for India.

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About the authors Determinants
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 of FDI in India
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 finance
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, 81
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 finance,
equity research and portfolio management.

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Table AI.
Appendix

AFDI, net Patent Real Money and quasi

Indicator_ inflows (in AGDP (current Trade of goods and Inflation, consumer applications, interest money growth (annual
Name million $) million US$) services (% of GDP) prices (annual %) residents rate (%) %)

1991 135.49398 492,915.2519 9.325931366 13.8702461 1,267 3.643792 18.31695

1992 467.51846 415,173.5141 11.02685592 11.78781925 1,248 9.1230537 16.862495
1993 847.43209 425,028.4548 12.91298702 6.362038664 1,209 5.866608 17.007663
1994 1,362.3514 452,832.6104 14.51065563 10.21150033 1,588 4.3176331 20.277728
1995 2,750.9168 457,238.3093 18.02513709 10.22488756 1,545 5.8517736 11.011121
1996 2,894.8965 463,392.0096 18.59386749 8.977149075 1,661 7.8216536 18.736274
1997 4,009.6971 460,579.6345 20.41998323 7.16425362 1,926 6.9276375 17.656754
1998 2,734.7796 432,071.8031 23.10683746 13.2308409 2,247 5.1481985 18.173015
1999 2,168.5911 450,476.1993 25.27613491 4.669821024 2,206 8.4212005 17.14918
2000 3,462.1403 444,508.4099 28.34717907 4.009433962 2,179 8.467056 15.171708
2001 5,130.2686 448,011.0878 28.16591393 3.684807256 2,371 8.7899864 14.320551
2002 5,081.8389 458,130.025 33.17512609 4.392199745 2,693 7.8238091 16.761165
2003 3,770.5321 522,882.3371 35.42644028 3.805865922 3,425 7.6309535 13.033611
2004 4,767.4867 579,008.5128 45.93258842 3.76723848 4,014 5.0437235 16.732333
2005 6,033.2839 642,598.001 53.62334276 4.246353323 4,521 6.3410241 15.599904
2006 15,365.966 691,297.8886 62.79002535 5.799385426 5,314 5.9200689 21.633141
2007 18,101.489 847,826.4174 63.69109264 6.369996746 6,000 7.7541577 22.271503
2008 27,922.189 786,195.8179 74.74805544 8.351816444 6,500 6.6817551 20.49521
Source: World Bank Databank, available at: http://data.worldbank.org/country/india (accessed July 20, 2010)