Determinants Of Foreign Direct Investment In India
TOKYO UN IVERS ITY OF FOR E IGN S TUD IESDeterminants of ForeignDirect Investment inIndiaRegion-Sector-Wise AnalysisYu ki T su ch i ya (8211156)Feb ruary 12, 2015Abs t ract : Whil e there are a num ber of empi ri cal studi es on t he im pact andthe det ermi nant s of Forei gn Di rect Investm ent (FD I), few of the researchhave been im pl em ent ed i n t erms of Indi a at t he regi on l evel . In t hi spaper, t he det ermi nant s of FD I t owards Indi a (dat a from t he peri od 2008 2013) woul d be ex ami ned regi on -wi se, using st at e -wi se dat a. S ect or -wis eGDP would be used as a vari abl e i n order t o anal yz e whi ch m arket beingthe si gni fi cant det ermi nant . It reveal s that general l y FD I i n Indi a i srel at ed posi ti vel y wi th GDP per capit a, l engt h of st at e and nati onalhi ghwa ys, GDP of servi ce sect or, num ber of t el ephones per 100popul ati ons, and am ount of nat ural gas produced. Especi al l y t he resul tsreveal ed t hat the FD I i nfl ows have a si gni fi cant rel ati on wit h t he m arke tsiz e of t he servi ce sector of t he i ni ti al year.
Table of ContentsFor Acknowl edgem ent . 31.Int roducti on . 41.1.Term i nolog y . 51.1.1. Forei gn Di rect Investm ent (FD I ) . 51.1.2. Gross Dom esti c P roduct (GDP ) . 61.2.Di scussi on on FD I . 61.2.1. FD I as for Indi a . 81.3.Di scussi on about FDI Im pact on Econom i c Growt h . 81.4.Governm ent of Indi a FD I P ol i ci es . 101.5.Wh y re gi on -s ect or -wi se Indi a i s the S ubj ect . 141.6.Li t erat ure R evi ew . 192.Dat a . 242.1.Sam pl e S t at es, Uni on Territ ori es, and R egi ons . 242.2.Dat a Descri pti on and Theor y . 261
3.Model and Method . 293.1.4.Model Buil di ng . 29Resul ts and Anal ys e s . 324.1.Resul ts and Anal yse s on Ex pl anat or y Va ri abl es . 324.2.Resul ts and Anal yse s on St at es, Uni on Territ ori es, andRegi ons 355.Concl usi on . 406.References . 412
For AcknowledgementI woul d l i ke to ex press m y great appreci ati on to P rofessor Kimi ko Unofor her val uabl e and const ructi ve sugges ti ons and assist ance duri ng t hework of t hi s st ud y.I woul d al so li ke t o thank all the m em bers in P rofessor Uno ’s sem i narfor gi ving const ructi ve feedbacks to this st ud y. Di scussi ons t hat weredone i n t he semi nar were ver y i nsi ght ful .3
1. IntroductionIn recent years, Forei gn Di rect Investm ent ( FD I) has been regarded as anim port ant fact or for economi c devel opm ent . As for Indi a, t he am ount ofFD I has an i ncreasi ng t rend, and al so t he Gross Dom est i c P roduct (GDP )is i ncreasi ng ever y ye ar. In m ost em pi ri cal st udi es, it is concluded t hatFD I cont ri but es t o bot h fact or producti vit y and i ncom e growth i n hostcount ri es, be yond what dom esti c invest m ent woul d norm al l y c ause(OEC D, 2002) . This i s consi dered to be also t he sam e as for Indi a(Kundra, 2009) . Wi t h FD I and GDP ’s gr owi ng amount , t he i nt eresttowards Indi a as a dest inati on of FD I ha s been growi ng i n J apan, andrecent l y Indi a has assi gned ke y a greem e nt s wit h Japan t o share ‘S peci alSt rat egi c Global P artnershi p ’ (C haudhury, 2014).Under the considerati on of previ ous em pi ri cal st udi es on t herel at ion of FD I and GDP , it coul d be st at ed t hat FD I t ri ggers econom i cdevel opm ent i n Indi a. As m ent i oned above, the amount s of FD I have anincreas ing t endenc y. However, t he am ount of FD I wi del y var i esdependi ng on each s t at e. If more st at es be abl e t o call in a l arger am ountof FD I, t he economi c gap among st at es would decrease. In a ddit i on, t hewhol e nati on woul d be enabl ed t o i ncrease it s GDP.The purpose of t hi s thesi s i s t o ex ami ne the det ermi nant s of FD Itowards Indi a. In t hi s pape r, FD I woul d be regarded as a positi ve factoron economi c devel opm ent . B y usi ng regression m odel and regi on -wi sedat a, t he det erm i nants i s t o be observed. Fi nall y t o anal yz e how toprom ot e and i ncrease t he am ount of FD I t hat will benefi t both t he hostand invest ing nat ions.4
1.1. TerminologyIn order t o cl ari f y t he m ain t erm s used i n t hi s paper, som e of t he m ostim port ant words woul d be defi ned i n t hi s secti on .1.1.1.Foreign Direct Investment (FDI)The t erm “FD I” i s defined i n t he Balance of Payment s Manual Fi ft hEdit i on ( IMF, 1993) and i n Det ai l ed Benchmark of Forei gn Di rectInves t ment : T hi rd Edi ti on (OEC D, 1996) . Accordi ng t o UNCTAD , “FDIr ef ers to an investment made to acquire last ing i nt erest in ent erprisesoper at ing outside of t he economy of t he i nvest or. Further, i n cases ofFDI, the invest or s purpose i s t o gai n an eff ect i ve voi ce i n t hemanagement of t he e nt erprise. T he f orei gn ent it y or group of associ at edent it i es that makes t he i nvest ment i s t ermed t he " di rect invest or" . Theuni ncorporat ed or i ncorporat ed ent erprise -a branch or subsidiary,r es pecti vel y, in whi ch direct i nvest ment i s made -i s ref erred t o as a"dir ect i nvest ment ent erprise" . Some degree of equit y ow nership isal mos t alw ays consi dered t o be associ at ed wi t h an eff ecti ve voi ce in t h emanagement of an ent erprise; the BPM5 suggests a threshol d of 10 percent of equit y ow nership to quali f y an i nvest or as a f orei gn di rectinvest or.” 1 In short, FD I are i nvestm ent s t hat are done t o di rectl y gai nint eres t s b y adm i ni strat ing fi rms i n host cou nt ri es, such as M&A and1UNC TAD “Forei gn Di rect Invest m ent ” (1999)5
green fi el d i nvestm ent . It does not incl ude i nvestm ent s whi ch are donevi a s ecurit i es (so call ed Forei gn P ort foli o Investm ent ).1.1.2.Gross Domestic Product (GDP)The t erm “GDP ” is defi ned i n SNA 1.128 and 2.173 -2.174 (OEC D, 2001).Accordi ng to OEC D, “ Gross domesti c product is an aggregat e measureof pr oducti on equal to t he sum of t he gross val ues added of al l resi dentinst it ut i onal unit s engaged in product ion (pl us any t axes, and mi nus anysubsi di es, on products not i n cl uded i n t he val ue of t hei r out put s). T hesum of t he f inal uses of goods and servi ces (al l uses except i nt ermedi at econs umpti on) measured in purchasers' pri ces, l ess t he val ue of i mportsof goods and servi ces, or t he sum of pri mary i ncomes di stri but ed byr es ident producer uni ts.” 21.2. Discussion on FDIFD I t owards devel opi ng count ri es has becom e an i nt ernati onal t rend. In2009, FD I b y pri vat e equit y funds and soverei gn wealt h funds t oget heraccount ed for over 10% of gl obal FD I fl ows. P E funds are al so m aj orcont ri but ors to cross -border M&A whi ch was t he m ai n fact or of theincreas e of gl obal FD I (see Tabl e 1). But in the recent years, a ccordi ngto UNC TAD 3 , alt hough the gl obal FD I rose b y 11%, the developi ng2OEC D “OECD Glossar y of St ati st i cal Terms ” (2008)3UNC TAD “Global Investm ent Trends Monit or No. 15 ” (2014)6
nat ions are t rapped i n a hi st ori cal l y l ow share (39%). Despit e t heinform ati on above, t he am ount towards devel oped count ri es i ncreased b y12% to US 576 bil li on . FD I t o t he European Uni on i ncrease d, whi l efl ows t o the Uni t ed St at es decl ined. UNCTAD forecasts that t he gl obalFD I fl ows wil l rise graduall y i n 2014 and 2015, t o US 1.6 t rill i on andUS 1.8 t ril li on respecti vel y.Tabl e 1. C ross -Border M&As b y P ri vat e Equit y Fi rms 2000 -2010 (ci t edfrom “ Indi a s FD I Infl ows Trends and C oncepts ” b y K.S . C hal apati R ao,Bis waji t Dhar, 2011)7
1.2.1.FDI as for IndiaIndi a has been di st i nguished am ong t he worl d as a FD I dest i nat ion i nrecent years as wel l as it s rapi dl y growi ng econom y . Accordi ng toUNC TAD 3 , it has ex peri enced a 17% gro wt h i n FD I i nfl ows, to US 28bi ll ion. As a m em ber nati on of t he BR IC S, Indi a has been cont inuing t obe a st rong perform er i n at t ract ing FD I. BR IC S s curr ent share of gl obalFD I fl ows are 22%, whi ch i s as t wi ce of it s num ber before t he fi nanci alcris is i n 2007 -08. In l at e 2012, 6 nat i ons i ncl udi ng Indi a whi ch areAS EAN ’s FTA part ners l aunched t he negot i at ion of the R egi onalComprehensi ve Economi c P art nership (RC EP ) . Accordi ng t o UNCTAD 4 ,Indi a has concluded negoti ati ons wi th ASEAN on t rad e i n servi ces andon invest m ent on December 20, 2012. In addit i on, an FTA between EUand Indi a are under negoti ati on si nce 2007. This is expect ed t o i ncl ude asubst ant i ve invest m ent prot ect i on chapt er .1.3. Discussion about FDI Impact on EconomicGrowthAl t hough there are m an y t heori es about t he FD I i mpact on economi cgrowth, m an y of t hem cl ai m t hat FD I ha s a posit ive effect on hostcount ri es ’ econom i c growt h. Generall y, FD I i s consi dered t o bri ngvari ous benefit s such as t echnol ogy developm ent, increase ofemplo ym ent , and ex pansion of int ernat i onal net works and so on.4UNC TAD “ IIA Issues Not e No. 3 ” (2013)8
In t he recent years, the posi ti ve econom i c effect of FD I i n bot hhost and hom e count ri es has com e t o be more and more appreci at ed.Accordi ng to Jun and Brewer 5 , The i nt erest i n t he broader rol e of FD I i nsust ai nabl e develo pm ent has been i ncreased. As not e d b y F eldst ei n 6 ,there are several advant ages that could be gai ned b y t he FDI host st at e.Fi rs tl y, FD I woul d enabl e t he t ransfer of t echnol ogy. Thi s t ype ofbenefi t woul d especi all y work on t echnol ogy t hat cannot be gainedthrough fi nanci al i nvestm ents or t rade i n goods and servi ces. It woul dals o prom ot e compet iti on i n t he dom est i c i nput m arket . S econdl y, therecipi ent s of FD I ca n gai n emplo yee t rai ni ng in t erm s of operati ng newbusi nesses t hat woul d cont ri but e t o hum an capit al developm ent . Thi rdl y,the profit s gai ned by FD I cont ribut e t o corporat e t ax revenues i n thehost count r y.It i s considered t hat t he cont ri buti on of FD I t o sust ainabl edevel opm ent depend on com bi nat i ons of proj ect feat ures and governm entpoli ci es in an y c ase. In order to im prove t he cont ri bu ti ons , Jun andBrewer 7 st at e t hat a vari et y of publ i c sector i nst it ut ions as well ascorporati ons coul d devel op pol i ci es t hat wi ll increase t he cont ributi on.5Kwang W. Jun, Thom as L. Brewer and t he World Bank “The R ol e ofForei gn C api t al Fl ows in S ust ainabl e Devel opm ent ” (1997)6M arti n F eldst ei n “Aspects of Gl obal Economi c Int egrat i on : Out look forthe Fut ure ” (2000)7Kwang W. Jun, Thom as L. Brewer and t he World Bank “The R ol e ofForei gn C api t al Fl ows in S ust ainabl e Devel opm ent ” (1997)9
Thi s also i ncludes host governm ent poli ci es. However, t he hostgovernm ent must be m indful of the pot ent i al l y harm ful effects of FD Iproj ects. Jun and Br ewer al so m ent ions as cit ed bel ow. “ Improving t hecont ri buti ons of f oreign capit al t o sust ainabl e devel opment , how ever,r equir es much more than si mpl y increasi ng the amount s of f orei gninvest men t in developi ng count ri es. It al so requires host governmentpoli ci es that f ost er competi ti on (and cont rol rest ri ct i ve businesspr acti ces ) wi t hi n t he economy and t hat al low t he di verse t ypes ofint er nat ional t ransacti ons t hat are essenti al t o t he successf ul operat i onof t ypi cal FDI proj e cts. Such pol i ci es w i ll maxi mi ze t he pot e nt iall ybenef i ci al cont ri buti ons of FDI proj ect s to sust ai nabl e devel opment. ” 71.4. Government of India FDI PoliciesIt coul d be sai d t hat FD I i n Indi a st art ed wi th t he est abl ishm ent of EastIndi a C om pan y i n 1600. Aft er t he S econd W orld W ar, Japanesecom pani es st art ed t o i nvest i n the Indi an m arket. Al though Indi a hasbeen not i ced as a huge m arket and dest i nat ion of FD I, i ts governm entpoli c y t owards FD I has went t hrough m an y changes. The pol i c y al sovari es dependi ng on each st at e governm ent . Aft er t he i ndependence ofIndi a, t he att enti on t owards busi ness of mult inati onal corporati ons(M NC s ) rose, especi all y for t he poli c y m akers. In 1965, an i ndust ri alpoli c y was m ade all owi ng the MNC s t o vent ure t hrough t echni calcol l aborati on. Therefore, the governm ent of Indi a adopt ed a rel at ivel yli beral st ance b y al l owi ng more equi t y.10
The corrupti on has been consi dered as a m ajor obst acl e b y t heM NC s when invest i ng in Indi a. As a whol e nat ion, Indi a ranked 142 n dout of 189 nati ons i n t he Eas e of Doi ng Business Index 8 i n 2014. It i scons idered corrupt i on is st il l l arge. In addi ti on, t he federal ism is m akingthis i s sue more com pl ex t o t he MNC s si nce t he l evel of corrupti ondi ffers l argel y dependi ng on each st at e (see Fi gure 1). However, AamAadm i P art y (AAP ), whi ch is a st at e pol iti cal part y based on Del hi(NC R ) put ti ng up an i deol ogy of anti -corrupti on, has won 28 out of 70s eat s i n t he 2013 Delhi l egi sl ati ve assem bl y el ecti on. W it h no part yobt ai ning an overal l m ajorit y, t he AAP em erged as the second l argestpart y i n NCR . In t he 2014 Indi an general el ecti on (whi ch was hel d t ocons ti tut e t he 16t h Lok S abha, el ect i ng m em bers of parli am ent for all543 parl i am ent ar y c onst it uenci es of Indi a. R un i n ni ne phases fromApri l 7 t o Ma y 12, 2014 ), t he Bharat i ya Janat a P art y (BJP ) won 31.0%of all vot es and 282 (51.9%) of al l seats 9 . For resul ts of t he nati onal andregi onal part i es b y a lli ances, see t he fi gure below (Fi gure 2). It was t hefi rs t ti m e since the 1984 Indi an general el ect ions t hat a singl e part ywi nni ng enough seat s wit ho ut t he support of other part i es. The BJ Pparl i am ent ar y l eader Narendra Modi , who l ed a posit ive FD I poli c y asthe previ ous St at e P ri m e Mi ni st er of Guj arat , was sworn i n as t he 15t hPrim e Mi ni st er of Indi a on 26 Ma y 2014.8Worl d Bank “Doi ng Busi ness 2015 Econom y P rofi l e 201 5 Indi a ”(2014)9S ource: El ecti on C om mi ssi on of Indi a “General El ecti on t o Lok S abhaTrends & R esult 2014 ”11
Fi gure 1. S t at e -Wi se C orrupti on Index (2005)Source: Transparency Int ernati onal S urve y (2005)12
Fi gure 2. R esul ts of the nat ional and regi onal parti es b y al li ancesSource: El ecti on C ommi ssi on of Indi a13
Under the Forei gn Exchange Managem ent Act (FEMA), forei gninvest m ent was i nt roduced t o Indi a in 1991. The t hen Fi nance Mi ni st erwas M anm ohan S i ngh (Si ngh was the previ ous P rim e Mi ni st er). InSept em ber 2012, a new FD I pol i c y i n ret ail was int roduced. Thi sall owed a ful l forei gn i nvest m ent i n si ngl e brand ret ai l, and 51% inmult i brand ret ai l . B esi des ret ai l , the go vernm ent al l ows FDI i npharm aceut i cal indust r y (100%), t el ecomm uni cat i on indust ry (100%),and ins urance indust r y (49%) am ongst ot her i ndust ri es. In theCons oli dat ed FDI Pol i cy of t he Depart m ent of Indust ri al Pol i c y andProm oti on, Mi ni st r y of C omm erce and Indust r y, Governm ent of Indi a , i tis wri tt en as bel ow: “It i s the int ent and obj ecti ve of t he Government ofIndi a to at tract and promot e f orei gn di rect i nvest ment i n order tosuppl ement domesti c capit al , t echnol ogy and skil l s, f or accel erat edeconomi c growt h. Forei gn Di rect Invest ment , as disti nguished f romport f ol io i nvest ment , has the connot ati on of est abl ishing a ‘last ingint er es t ’ in an ent erprise that is resident in an economy ot her t han t hatof t he i nvest or.” 1 01.5. Why region-sector-wise India is the SubjectThe R epubl i c of Indi a (see Fi gu re 3 ) is a federat ion consi st i ng 29 st at es(t he 29 t h st at e Tel angana was divi ded from Andhra P radesh on June 2,2014), and each of t hem owns a st rong aut onom y. The di versifi cati on ofpoli ti cal parti es due t o t he ri se of l ocal part i es caused poli ti cal10Governm ent of Indi a “C onsol i dat ed FD I P ol i c y ” [ Chapt er -1, 1.1,1.1.1] (Effecti ve from Apri l 17, 2014)14
decent raliz ati on of power. Therefore from 1990 onwards, t he prom oti onof i ndust ri al poli c y, i nfrast ruct ure devel opm ent , preparati on ofeducat ional facil it i es, et c. has been carri ed out b y each st at e governm ent .For i ns t ance i n Guj arat, posi ti ve FD I pol i ci es l ea d t o a rapi d economi cgrowth (the then S t at e P ri m e Mi nist er was t he current Federal P ri m eMi ni st er Narendra Modi ).Fi gure 3. The Poli ti cal Map of Indi aSource: www.m apsofi ndi a.com (2014)15
There are m ai nl y t wo reasons wh y Indi a was chosen as the subj ectfor t hi s st ud y. Fi rstl y, Indi a has been ex peri encing a rapid economi cgrowth si nce t he 2000s (see Fi gure 4 ). In t he l at e 2000s, i t s growth rat ereached 7.5%, and t hi s doubl ed the average i ncom e i n a decade . As t heeconom y grew t he F D I i nfl ows have al s o i ncreased rapi dl y ( see Fi gure5 ). In addi ti on, a recent UNC TAD survey shows Indi a as t he secondmost i m port ant FD I desti nati on aft er C hi na, especi all y for t ransnati onalcorporati ons from 2010 t o 2012 1 1 . Therefore, Indi a has been recogniz edas a huge m arket and al so as a desti nati on of FD I am ong t he world. It isobvious that t he stud y about FD I t owards Indi a m ust be done furt her i norder to gai n benefit for bot h t he hos t and hom e invest ing count ri es.Secondl y, i t i s n ecessar y t o anal yz e t he Indi an FD I i nfl ows regi on -wi seto i m pl em ent an out -and -out devel op of the Indi an econom y as a whol enat ion . The current FD I t owards Indi a are concent rat ed t o som e regi onsas s hown i n t he t abl e bel ow (see Tabl e 2). As m ent i oned i n 1.4Gover nment of India FDI Pol i ci es and t he previous paragrap h , Indi a spoli ti cal st at us is compl ex due to local pol it i cal part i es and corru pti on.Therefore, t he R epubl i c of Indi a i s recent l y ex peri enci ng a huge soci al economi c t ransi ti on and devel opm ent . Thi s i s wh y i t i s wort h st ud yi ngon FD I t owards Indi a regi on -wise.11S ource: Bhav ya Ma lhot ra “Forei gn Di rect Investm ent: Im pact onIndi an Econom y” (2014), p. 1816
Fi gure 4. GDP per capi t a and GDP growth rat e of Indi a 1960 -2012121086420-2-4-6-8GDP per capita (current US )GDP growth (annual 4002000Source: World Development IndicatorsFi gure 5. Forei gn Di rect Investm ent net i nfl ows 1960 -2012500000000004000000000030000000000Foreign direct investment,net inflows (BoP, currentUS )20000000000100000000000Source: World Development Indicators17
Tabl e 2. S t at e-wise N
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