Impact of gross domestic product on inflow of foreign direct investment in India

By Indra Giri on December 27, 2016

The inflow of foreign direct investment (FDI) in India has paved the path for the economical and financial development of a country. There has been a significant increase in economic growth after the liberalization policies undertaken by India in 1991 (Nagaraj 1997). Though the journey to growth has not always been a smooth trend for India. However, the reformation has improved the gross domestic product (GDP) over the years. It has indicated sound growth especially in recent years when the inflow of foreign capital has increased immensely (Sahni 2012).

High gross domestic product after economic liberalization

Gross Domestic Product (GDP) is the market value of all the goods and services produced within the geographical boundary of the country. It aids in determining the total product produced within the country. It also reflects on the standard of living of the people within the domestic territory (Pattayat 2016). Nominal GDP seeks to evaluate the market values of the product at the current prices. On the other hand GDP per capita aids in evaluating the economic growth of the country (Malhotra 2012).

Significant increase in the gross domestic product after liberalisation of1991
Gross Domestic Product of India (1960 -2014) Source: Planning Commission

Gross domestic product is also used to compare productivity within a given time period. Tracking it for a long period of time provides information to the investors about the economic state of the country. Therefore, in the case of India foreign investors often get induced to invest in the country for its rising growth rate (Agrawal & Khan 2011). In recent years after 2000, the gross domestic product of India has taken-off to shine as the third nation with respect to the purchasing power parity with 3.611 trillion USD. With respect to the USD exchange rate, India stands at the tenth position with a GDP of 800.8 billion US dollars in 2006 (Narayana & Babu 2008) and according to the World Report, India is the second-largest growing economy with a GDP rate of 7.56% in 2015.

India ranked 10th in terms of receiving foreign direct investment
Top ten countries in terms of receiving foreign direct investment (Source: UNCTAD,. 2015)

However, this was followed by certain crests and troughs due to political and economic instability within the country and reached a stability between 2003 and 2007 (Handbook of Statistics 2015). The global financial crisis which started from the collapse of Lehman Brothers in the USA had an impact on the economy of India too. As a result, the growth rate declined to 6.22% in 2008 (Gola et al. 2013). This was followed by a hike in 2010 and a sharp fall in 2011 and 2012 with growth rate reaching the lowest of 3.2%. The main reasons behind such low growth were due to the political turmoil within the country along with poor infrastructural growth and increased corruption. India revived to form the situation in two years’ time and reached 7.24% in 2014 and 7.56% in 2015 (Handbook of Statistics 2015).

A positive relationship between economic growth and foreign direct investment in India

Larger market size attracts foreign investment. In the Indian context, the large size of market is measured in terms of population and gross domestic product. With an increasing growth rate and with the second-highest population in the world has resulted in increased production. The economies of scale and optimum utilization of the resources in the large market is not only beneficial to the investors but also to the growth of the country. Therefore, the increasing growth rate of India has attracted more foreign investment to the country than any other determinants (Maheswari 2015).

Increase in inflow of foreign direct investment in India in 2015 as compared to 2014
The inflow of FDI in major economies in 2014 and 2015   Source: UNCTAD (2016)

The trend of foreign investment and the gross domestic product started with a slow rise in economic growth and a gradual increase in foreign direct investment until 2006. This was due to the hindrance in the path of investment inflow in India as the policies of India did not permit relaxation.

However, due to certain internal turmoil such as the great recession faced by the world and the variant financial crisis within the domestic boundary inflow of foreign investment has been fluctuating (Gupta & Garg 2015). In 2013 India faced a political instability for which the growth fell to the minimum in the decade. Therefore, it affected the inflow of foreign direct investment which fall from 46556 billion USD to 36556 billion USD. However, after 2013 the inflow of foreign direct investment revived  to 44208 billion USD in 2015 as economic growth increased (Handbook of Statistics 2015).

Statistically checking the relationship between gross domestic product and foreign direct investment

The correlation between the FDI inflow and GDP (per capita) indicates that there is a high positive correlation of 0.7406. This suggests that with an increase in one factor the other tends to increase in the Indian context. Therefore, with an Indian perspective, it can be stated that gross domestic product is a major determinant for foreign direct investment. Economic growth of the country attracts foreign capital as the investors are interested in the prosperous future of India. The trends of the inflow of FDI and GDP also supports the positive correlation between them.

positive and high correlation between gross domestic product and inflow of foreign direct investment
Correlation between gross domestic product and foreign direct investment in India

Similarly in the long-run association between the gross domestic product and foreign direct investment can be seen in the co-integration analysis (shown in the figure below). So, the positive relationship between the two variables has also been established statistically.

long run association between gross domestic product and inflow of foreign direct investment in India
Co-integration analysis between gross domestic product and the foreign direct investment in India

Existence of two way relationship

GDP as one of the main determinants of foreign investment has initiated the inflow. At the same time the higher inflow of foreign capital has led to the further economic growth of the country (Agrawal & Khan 2011). This is because with higher capital inflow there is an increase in the production of goods and services and employment opportunities. As a result, this increases the gross domestic product and makes the economy more attractive to foreign investors.

However despite the rapid economic growth, India has faced a low foreign investment inflow as compared to other developing nations. This is because other determinants were not suitable to attract investors. Besides economic growth, other determinants also plays an important role. The focus should also be in development of the country along with the economic growth. This will further lead to the evolution of India as a developed nation in the future.


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