Investors' Perception & Domestic Private Investments in India-Role of Direct Foreign Investments & Economic Reforms

By Vadlamannati, Krishna Chaitanya; Irala, Lokanandha Reddy | Indian Journal of Economics and Business, June 2009 | Go to article overview

Investors' Perception & Domestic Private Investments in India-Role of Direct Foreign Investments & Economic Reforms


Vadlamannati, Krishna Chaitanya, Irala, Lokanandha Reddy, Indian Journal of Economics and Business


1. INTRODUCTION

Most of the economists in India are of the belief that it is absolutely essential for India to improve their investments in order to generate sustained economic growth that creates employment opportunities for their growing workforces in the years to come. They strongly recommend the government to undertake investments in key physical and social infrastructure, as well as pursue structural economic reforms policies that attract large chunk of FDI.

There is substantial evidence to show that the macroeconomic growth and development is spurred by rapid FDI inflows. Also, FDI inflows generate substantial direct and indirect positive spillover effects in the form of transfer of technology. This in turn leads to increased productivity and there by stimulates domestic private investments in the host country (Aschauer, 1989; Bloomstrom & Wolff, 1994; Cuadros et al., 2004; Cardoso, 1993; De Mello, Jr., 1997; Green & Villanueva, 1991; Huang, 2004; Ramirez, 2000; Ram & Zhang, 2002). Higher investments activities would naturally attract the attention of foreign investors and thus improve the foreign investor's perception about the host country.

This paper employs time series data in order to test empirically two critical aspects. One, whether FDI flows have had a positive and significant effect on India's domestic private investments over the period 1975-2006. We also test the role of economic reforms on domestic private investments. We then examine whether FDI inflows have significant impact on domestic private investment activities. Two, whether foreign investors' country rating for India is determined the by investment activities (private, public & foreign)? If so, how important is the role of FDI inflows? Also, examined is the importance of economic reforms process for foreign investors' ratings. In so doing, it is one of the first empirical studies related to India to investigate the complementarily hypothesis between domestic private investment and FDI along with the role of economic reforms for the period in question.

The rest of the paper is organized as follows. Section II presents detailed literature review on this topic. The third section deals with research design and methodology. Section IV presents the empirical results for all the models. The last section summarizes the findings and offers some policy prescriptions for improving the investment climate in India.

2. LITERATURE REVIEW

There are many studies in the literature which have estimated the impact of FDI inflows on domestic private investments (1). The study on transition economies by Krkoska (2001) shows that capital formation is positively associated with FDI and acts as complimentary to domestic capital.

Ramirez (2001) presents theoretical and empirical linkage of complementarily hypothesis between FDI and domestic investments for Latin American countries from 1981-2000. The findings show that FDI and public investment spending have a positive and significant effect on private capital formation.

Hecht, Gad & Shinar (2004) econometrically explore the interactions between domestic investment and various types of capital inflows for sixty-four countries for the period 1976 to 1997. The findings show a significant impact of the domestic investment on FDI inflows after controlling for other factors of these inflows. Nevertheless, in terms of impact on domestic investment, FDI inflows are ranked highest, above the other types of capital inflows.

Desai, Foley & Hines Jr. (2005) evaluate the impact of FDI outflows on domestic investments. They find that OECD countries with high rates of outbound FDI in the 1980s and 1990s exhibited lower domestic investment than other countries, which suggests that FDI and domestic investment are substitutes. In a recent study on FDI and domestic capital relationship.

In a study on Sub-Saharan African countries, Ndikumana & Verick (2008) explore the two-way linkages between FDI and domestic investment.

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