Journal of Positive School Psychology http://journalppw.

com
2022, Vol. 6, No. 2, 323 – 331

IMPACT OF FOREIGN DIRECT INVESTMENT ON

ECONOMIC GROWTH: EVIDENT FROM INDIAN
ECONOMY

Niharika Mehta1, Dr. Seema Gupta2,

1
Research scholar, Amity University, Noida, Uttar Pradesh,
2
Professor, Amity University, Noida, Dr. Shilpra Maitra, Sr. Professor, Institute for Human Development.

Abstract
Foreign Direct Investment is considered to be one of the major contributors to the growth of economies
thus attracting researcher’s attention to this area. FDI is well known for driving economic growth thus
this paper attempts to investigate the impact of Foreign Direct Investment on the Economic Growth of
India. FDI is assumed to be a crucial driving force of the economic growth of the nation. However,
empirical evidence shows mixed results. We aim to establish both the long and short-term impact of
FDI on growth. Time series data for two decades ranging between the time period from 1991 to 2020
has been used and results reveal there is a significant influence of FDI on economic growth in the long
run, also in the short run FDI directly as well as indirectly affects the growth via its integration with
human capital.
Keywords: FDI, Economic Growth, Indian Economy, ARDL Model, human capital

Introduction of FDI is through MNC’s. MNC’s bring new and

better technology, improve the profitability of
Foreign Direct Investment (FDI) has been the company through spillover of technology
identified as one of the major determinants of and managerial knowledge, raising productivity.
economic growth and has resultantly attracted
the attention of policymakers, academicians, It has been believed by researchers that FDI is
and government. FDI is used widely to fill the one of the major contributors to the growth of
gap between savings and investment which in developing nations. Foreign Direct Investment
turn improves infrastructure, increases demand is used to fill in the gap between the required
for labor generates employment, increases investment by the nation and the domestic
wages, production, competition among domestic savings. It is a major source of external finance
players hence improving the quality of goods and capital formation and enhances the growth
and services thus the standard of living. Most of of the economy (Falki, 2009).
the economic growth is due to capital inflow and
the transfer of technology through foreign firms. As per earlier research, Foreign Direct
FDI increases the export of the host country Investment affects economic Growth in majorly
increasing inflow of foreign exchange. 2 ways:

FDI is crucial for developing countries as host 1. The inflow of foreign funds for
countries benefit from FDI through funding, domestic investments creates jobs. Improves
investment, infrastructure facilities thus creating technology and knowledge thus increasing
jobs, providing higher wages, technology economic growth (Dritsaki & Stiakakis,
transfer, and increasing economic growth 2014)and (Melnyk, Kubatko, & Pysarenko,
(Dritsaki & Stiakakis, 2014). Developed 2014)
countries like the USA and the EU also rely on 2. Inward FDI increases host counties
FDI. However, in such developed nations the productivity and hence improves
source of FDI is mergers and Acquisitions. In competitiveness which might increase exports
developing nations like India usually, the source
Niharika Mehta et al. 324

thus leading to economic growth (Moudatsou, his study of 23 Asian countries concluded FDI
2003) in the linking variable between technology and
economic growth also he went to explain the
Empirical studies reveal economic growth is a role of Human Capital to absorb the benefit
complex phenomenon that has bi-directional brought by FDI to the host country. (Sokang,
causality with factors affecting it. Also, a large 2018) in his research on effect of FDI on
number of factors that contribute to growth are economic growth of Cambodia from 2006-2016
themselves interrelated. Various studies reveal stated that FDI brings technology and benefit the
that factors affecting growth also are affected by host country through learning which results
growth in return. Various time series factors from spillover of human capital and technology.
such as GDP, FDI, Trade Openness, and human FDI in India has positive influence on Economic
capital are interlinked and they also have a bi- growth due to improvement of total factor
directional relationship with growth. It is productivity through spillover (Choi & Baek,
difficult to say if the increase in capital is leading 2017)
to economic growth or growth causes higher
capital formation. Similarly in a study conducted by (Lauzi &
Abadi, 2011)stated FDI has a positive and
With the growth of globalization and openness significant impact on the growth of economy but
of trade, the volume o FDI has increased. they also stated that FDI is not the sole factor
Although each country attempts to attain higher affecting economic growth such as flexible
growth each country has different ways however labor, trade policies, tariff structure, political
FDI plays an important role in enhancing stability, etc. Likewise results were revealed by
growth. FDI is a key to deriving economic (Singh et.al,2012) who emphasized on favorable
growth bringing financial stability, contributing effect of FDI on growth of India achieving its
to economic integration, and improving the goal through improved Balance of payment,
standard of living (Borensztein, Gregorio, & reduced poverty and improved economic
Lee, 1998). development. (Koojaroenprasit, 2012) stated
FDI has opportunities as well as challenges FDI has a positive effect on economy but other
associated with it. Thus, this paper attempt to factor such as human capital, employment and
analyze the short and long effect of FDI on the amount of exports are other crucial factors to be
economic growth of the Indian economy from considered. In a study conducted by Rehman, A.
the period of 1991-2020. The results of the study and Chakraborthy, S. (2015) on Bangladesh
will highlight what policies should be made to emphasized that FDI has positive affect on
enhance the benefits occurring as a result of the growth via managerial and technological
inflow of FDI on the growth of the nation. progress. A study conducted by (Silajdzic &
Mehic, 2015) showed technology and
innovation brought through FDI plays an
influential role in growth of the host country’s
REVIEW OF LITERATURE
economy. FDI along with development of
The linkage between Foreign direct investment human capital are essential for growth of the
and the growth of the economy has gathered a nation ( (Fadhil & Almsafir, 2015). (Raj &
lot of interest of academicians and economists. Pahwa, 2018) Stated FDI has a major role in
There is a huge amount of theoretical and economic growth and suggested ways to attract
empirical research on this topic especially due to more FDI to maximize the benefit achieved
mixed results. Theoretically, FDI is likely to through it.
benefit the economy and lead to economic (Omran & Ali, 2003) Indicated economic and
growth through transfer of technology, political condition of the host country are
increasing employment, increasing exports thus equally important as FDI in bringing economic
improving balance of payment. growth. (Balasubramanyam, Salisu, & Sapsford,
(Hymer, 1976) Suggested technology transfer 1996) stated greater the trade openness more a
benefits the firm by bringing in products, country is likely to benefit from FDI .similarly
processes and technical knowledge and also (Weinhold & Nair-Reichert, 2001)using cross
benefits the economy through spillover effect. sectional data observed FDI leads to economic
(Borensztein, Gregorio, & Lee, 1998) Through growth of various nations however the amount
325 Journal of Positive School Psychology

of growth varies depending on the level of trade (Aitken & Harrison, 1999) And (Carkovic &
openness. (Basu, Chakraborthy, & Reagle, Levine, 2002) concluded no significant impact
2007), went to say there is co-integration of FDI on economic growth even when the
between FDI and economic growth and had a bi- relation is positive the affect is very weak
directional causality between the variables Also, indicating there are other factors responsible for
(Liu, Burridge, & Sinclair, 2002) found economic growth other than FDI. A study
bidirectional relationship between FDI, conducted by (Konings, 2001)for a period of
economic growth and exports provided there is 1993-97 in Poland, concluded no positive
trade openness. On the contrary (Alfero, influence of FDI on economic growth of Poland
Chanda, Kelimli-Ozcan, & Sayek, 2004), due to reverse transfer of managerial and
concluded on his study of OECD countries that technical knowhow and trade imbalance. (yi &
effect of FDI on level of economic growth Chih-Chiang, 2008) for the period covering
depends on the level of financial market. 1997-2008 indicated no relationship between
FDI and economic growth. It was stated FDI can
Studies reveal FDI in one of the most used hinder the economic growth in short run while
variable to analyze GDP.As per the study human capital, domestic investment and
conducted by (Sayki, Commodore, & Opoku, domestic credit have positive impact on
2015)in Ghana for 1997-2010 stated increased economic growth in short run .However
FDI has a favorable impact on the GDP in long majority of literature says that FDI is a major
run. In a study by (Chakroborthy & factor influencing of economic growth.
Nunnenkamp, 2008) , for Indian economy, it
was found FDI and output are co-integrated in
long run. Similar results were found by (Waqas,
Research Methodology
2016)and found positive and significant impact
of FDI on GDP where GDP was used to The empirical analysis considers time series data
represent economic growth. of India from period of 1991 to 2020. The data
Borenstein,De Gregorio and Lee(1995) in their has been taken since 1991 as it was after 1991
study of 69 develop countries from 1970-89 that the policies were liberated and FDI
found FDI itself had marginal positive impact on welcomed.
economic growth but when FDI was interacted ARDL (Auto Regressive Distributed Lag)
with education it had a strong and positive model has been used in multivariate framework.
influence on the growth. Similar results were ARDL model has certain advantages over other
shown by a study conducted in China by (Mody co-integration techniques given by Johansen
& Wang, 1997) according to which interaction (1988) and Granger (1987). Firstly, ARDL
between school enrollment rate and FDI has model considers previous lags of dependent
significant and positive influence on growth. variable and current and previous lags of
(Borensztein, Gregorio, & Lee, 1998) Noted that independent variable. Secondly, unlike VECM
FDI alone is not significant contributor to the it considers endogenous as well as exogenous
growth as technology transfer depends on the variables. Thirdly, ARDL can be specified if
absorption capacity of the host county which variables are integrated at level one or are a
was measured by interaction FDI and schooling. combination of I(1) and I(0). Fourth, ARDL can
However as per a study conducted by specify both short and long term results
(Moudatsou, Foreign Direct Investment and simultaneously if the variables are co-integrated.
Economic growth In European Union, 2003) on
countries of EU from1980-1996 states economic ARDL is widely used in small data set (Hye,
growth is positively affected by FDI and trade Wizarat, & Lau, 2013).
openness but negatively by the level of
ARDL consist of two steps first is to find the
education and the interaction term of
short term relationship between the variables
FDI*education was not significant.
and second is to find the co-integration using
Another group that found results which were not bound test. If co-integration exists between the
in line with the above results were as there is variables then error correction term is
negative affect of FDI on economy. (Saltz, determined. The model in such case will be:
1992) found negative relation between FDI and
economic growth due to reverse causation.
Niharika Mehta et al. 326

𝒑
∆𝑮𝑫𝑷𝒑𝒄 = a + ∑𝒊=𝟏 𝜷𝒊 ∆𝑮𝑫𝑷𝒑𝒄 + to the government expenditure, DI is domestic
t 1 t-1
investment made in a country trade is trade
∑𝒒𝒋=𝟏 𝜱𝒊 ∆𝑭𝑫𝑰 + ∑𝒒𝒎=𝟏 𝜽𝒊 ∆𝑮𝑬 +
t-1 t- 1 openness measured as sum of import plus export
∑𝒒𝒏=𝟏 𝝅𝒊 𝑫𝑰 + ∑𝒒𝒏=𝟏 𝜶𝒊 𝑭𝑫𝑰 ∗𝑯 as a ratio of GDP, FDI*H is the interactive term
t- 1 o- i
𝒒 of FDI and human capital where human capital
+∑𝒐=𝟏 𝜶𝒊 ∆𝑻𝑹𝑨𝑫𝑬 + λECT +e
t- i t-1 t is measured as those who have enrolled in
secondary education.
where

a=constant
Results
t=time period measured quarterly
Unit root test
P,q=p is lag of dependent variable and q is lag of
independent variables Stationary is most important property to be
checked in case of time series data. It is essential
βi,Φj,θm,πn=short run dynamic coefficients of the
to know the order at which the variables are
model’s adjustment long run equilibrium integrated in order to determine which model is
to be applied. In order to analyze the stationary
et=Error term
property unit root test is used. In table below
Augmented Dickey-Fuller Test was applied to
λ=speed of adjustment
determine the order of integration among the
ECTt-1=the error correction term is the lagged variables under the study. As shown in table 1
variables are integrated at level I(0) and first
value of the residual obtained from the co-
difference I(1) it is appropriate to apply ARDL
integrating regression of the dependent variables
model. Variance inflation factor has been used
on the repressors, containing long run
to check multi colliniearity between the
information from long run co-integration
variables it was found that Human capital has
equation.
very high centered VIF due to which Human
GDPpc is the gross domestic product per capita, capital was removed from the list of independent
FDI denotes foreign direct investment, GE refers variable
Table 1: Unit root test

Variable At Level At first difference Findings

T- stats T-stats
(p-value) (p-value)

Chang in -2.8185 -6.4340 I(1)

GDPpc
(0.9515) (0.01)

Trade -4.01341 -7.6782 I(1)

openness
(0.2958) (0.001)

GE -3.7030 -8.0570 I(1)

(0.5629) (0.01)
327 Journal of Positive School Psychology

DI -5.6634 - 1(0)
(0.01)

FDI -3.1152 -7.0590 I(1)

(0.8748) (0.01)

FDI*H -22.6690 - I(0)

(0.01)

Co-integration and causality

The results of bound test reveal there is long run
co-integration between growth and FDI,
integrated variable FDI*h, domestic investment,
government expenditure and trade openness.
The best fit ARDL model is (1,2,0,0,1,0). The
lag length for the model is selected on the basis
of (AIC) Akaike Information Criteria.
Using bound test, null hypothesis which states
that there is no co-integration among the
variables has been rejected in favour of alternate
hypothesis to estimate short and long term
causality between the variables along with Error
Correction Term (ECT). ECT defined as the
speed with which dependent variable follows
independent variables.
Niharika Mehta et al. 328

Long run coefficient Short run coefficient

Variables coefficient Variables Coefficient

GE 0.0446 Change inGDPpc(-1) 1.7392

(0.000)** (0.1788)

DI 0.1970 GE 0.01882
(0.0072)** (0.9049)

FDI 0.0275 GE(-1) 1.6119

(0.001)** (0.0502)**

FDI*H 4.0571 GE(-2) 0.4906

(0.036)** (0.0718)**

TRADE 0.2539 DI 0.0433

(0.1855) (0.0025)

FDI 0.63310
(0.7049)

FDI*H 0.3713
(0.0236)**

FDI*H(-1) 2.4991
(0.1852)

TRADE 0.1381
ECT (0.7830)
-0.1484
(0.000)**

The above results reveal FDI, Domestic correction term is also significant at 5% and has
investment, and FDI*h have a positive and a negative sign indicating long-run convergence
significant effect on growth in the long run to equilibrium at a rate of 14.8%. However, in
however the integrated variable of FDI with the short run, FDI*H and lags of government
human capital has maximum influence on expenditure has
economic growth in the long run. The error
329 Journal of Positive School Psychology

Note;R2=0.48; Adjusted R2=.44;F- To check best fit of the model we used three tests
statistics=7.24(0.000);AIC=- .These also check the explanatory power of
2.616;DurbinWatson=1.97; probabilities are in ARDL model used above. First test is CUSUM
() **at 5% level of significance square test to check the stability of coefficients
of the model. As the model line is found to be
Impacted the economic growth while both of lying between the two bounds indicating
these variables have a marginal impact on stability of the model. Further results reveal
growth of Indian economy absence of serial correlation and
hetroskedasticity Indicating model is fit to be
used.
Daignostic Testing
1.6

1.2

0.8

0.4

0.0

-0.4
2004 2006 2008 2010 2012 2014 2016 2018

CUSUM of Squares 5% Significance

Conclusion and Implications capital also efforts should be made to improve

the level of education as human capital are able
The purpose of the paper is to find the impact of to benefit the economy by absorbing the
Foreign Direct Investment on growth of Indian knowledge and skills brought by FDI leading to
economy. The findings of the study suggest FDI, economic growth and development.
government expenditure and domestic
investment all have influenced economic growth
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