Journal of International Relations and Foreign Policy

June 2014, Vol. 2, No. 2, pp. 101-113

ISSN: 2333-5866 (Print), 2333-5874 (Online)
Copyright © The Author(s). 2014. All Rights Reserved.
Published by American Research Institute for Policy Development

Role of Foreign Direct Investment (Fdi) in India’s Economic Development-An

Analysis

Dr. M. Syed Ibrahim1 and A. Muthusamy2

Abstract

Foreign Direct Investment (FDI) plays an important role in global business. It can provide a
firm with new marketing channels, cheaper production facilities, access to technology
transfer, product, skills and financing. With the advent of globalization and strong
governmental support, foreign investment has helped the Indian economy grow
tremendously. India has continuously sought to attract investment from the world’s major
investors. In 1998 and 1999, the Government of India announced a number of reforms
designed to encourage and promote a favorable business environment for investors. Foreign
investments in the country can take in the form of investments in listed companies i.e.,
Foreign Institutional Investors’(FIIs) investments, investments in listed/unlisted companies
other than through stock exchanges i.e., through the foreign direct investment or private
equity/foreign venture capital investment route, investments through American Depository
Receipts (ADR), Global Depository Receipts (GDR), or investments by Non-Resident
Indians (NRIs) and Persons of Indian Origin (PIOs) in various forms. This paper attempts
to review the importance of foreign direct investments in Indian economy, particularly after
a decade of economic reforms and analyze the role played by the FDI in the economic
development of the country. The study is diagnostic and exploratory in nature and makes
use of secondary data. The study finds and concludes that the foreign direct investment in
India have significantly improved and developed the economy as well.

Keywords: Foreign Direct Investment, Economy, Gross Domestic Product,

Exports, and Foreign Exchange Reserves

I. Introduction

The history of foreign investment in India can be traced back with the
establishment of East India Company of Britain. British capital came into India
during the colonial era of Britain in India. Before independence, major amount of
foreign investment came from the British companies.

1 Assistant Professor and Research Supervisor, Post-Graduate and Research Department of

Commerce, Govt. Arts College (Autonomous), Salem-636 007. Tamil Nadu, South India.
2 Full-Time Ph.D.,Research Scholar, Post-Graduate and Research Department of Commerce, Govt.

Arts College (Autonomous), Salem-636 007. Tamil Nadu, South India.

102 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

British companies setup their units in mining sectors and in those sectors that
suit their own economic and business interest. After Second World War, Japanese
companies entered Indian market and enhanced their trade with India, yet U.K.
remained the most dominant investor in India. Keeping in mind the national interests,
the policy makers designed the Foreign Direct Investment (FDI) policy which aims
FDI as a medium for acquiring advanced technology and to mobilize foreign
exchange resources.

Foreign Direct Investment (FDI) means an investment through which the

non-resident investor and foreign company can start a new company can acquire an
effective share in an existing company in India with the specific objective of carrying
on industrial activities or business in India.

The need for foreign capital for a developing country like India could arise on
account of the following reasons:

a) Domestic capital is inadequate for purpose of economic growth and it is

necessary to invite foreign capital.
b) For want of experience, domestic capital and entrepreneurship may not flow
into certain lines of production. Foreign capital can show the way for domestic
capital.
c) There may be potential savings in a developing economy like India but this
may come forward only at a higher level of economic activity. It is, therefore,
necessary that foreign capital should help in speeding up economic activity in
the initial phase of development.
d) It may be difficult to mobilize domestic savings for the financing of projects
that are badly needed for economic development; the capital market is itself
underdeveloped. During the period in which the capital market is in the
process of development, foreign capital is essential as a temporary measure.
e) Foreign capital brings with it other scarce productive factors, such as technical
know-how, business experience and knowledge which are equally essential for
economic development.

II. Statement of the Problem

Foreign investment is an important economic process during which foreign

state and private companies and enterprises invest capital, technology and innovations
into the companies of another country.
Ibrahim & Muthusamy 103

As usual, the capital flows from developed countries to developing countries.

Modern world economy cannot develop successfully without foreign investment. A
great number of countries invest their funds to the economy of other countries
having a certain income and developing certain branches of industries of such
countries. Due to received capital the country receives an opportunity to renew and
develop all necessary branches of industries, to increase the effectiveness of
production and produce competitive goods and services. Foreign investment is a
predominant and vital factor in influencing the global economic development.
Foreign investment has been defined as “a transfer of funds or materials from one
country (called capital exploring country) to another country (called host country) in
return for a direct or indirect participation in the earnings of that enterprise. Hence,
this study is pertinent to analyze the impact of FDI inflows in the economic
development of India.

III. Objectives of the Study

In order to appreciate the importance of foreign direct investment for the

Indian economy, it would be pertinent to examine the changes in the global FDI
flows and the place of India within. In this respect the objectives of the study are;

1) To review the Foreign Direct Investments secured by the country;

2) To analyze the trends of Foreign Direct Investment;
3) To assess the impact of the FDI in the economic development of a country;
4) To offer suggestion for the improvement of the FDI for the economic
development of the country.

IV. Review of Literature

A considerable amount of research has been done on the working and

performance of FDIs in India, by academicians and researchers.

The literature obtained by investigators, in the form of reports of various

committees, commissions and working groups established by the Union Government,
the research studies, articles of researchers, is briefly reviewed in this part.
104 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

Stanley Morgan (2002) has examined in his paper that FIIs have played a very
important role in building up India’s Forex Reserves, which have enabled a lot of
economic reforms.

Lin et al. (2006) concluded that the investment performance of FIIs high
holding stocks is significantly better than that of FIIs low holding stocks. They
presented the evidence that FIIs trading behavior has generated better returns and
portfolio performance since the stock market’s full liberalization.

Douma, Pallathiatta and Kabir (2006) in their study investigated the impact of
foreign institutional investment on the performance of emerging market firms and
found that there is positive effect of foreign ownership on firm performance. They
also found the impact of foreign investment on the business group affiliation of firms.

Krishna Prasanna (2008) in his study examined the relationship between

foreign institutional investment and firm specific characteristics in terms of ownership
structure, financial performance and stock performance.

Sumana Chatterjee (2009) in his dissertation investigated different aspects of

FDI at the macroe-conomic level using aggregated data of FDI.

Sapna Hooda (2011) in her dissertation analysed the trends and patterns of
FDI flows at world level.

Sarbapriya Ray (2012) in his study assessed empirically the relationship

between Foreign Direct Investment (FDI) and economic growth in India using
annual data over the period of 20 years from1990-91 to 2010-2011.

Rahul Dhiman (2012) in his study concluded that FII do have significant
impact on the Indian Stock Market but there are other factors like government
policies, budgets, bullion market, inflation, economical and political condition etc.,
also having an impact on the Indian Stock Market.

Arshad Muhammad (2012) attempted to investigate the long-run co-

integrating relation among FDI, GDP, Export and Import for Pakistan.
Ibrahim & Muthusamy 105

V. Methodology

Methodology describes the research route to be followed, the instruments to

be used, universe and sample of the study for the data to be collected, the tools of
analysis used and pattern of deducing conclusions. The study carried out is an
analytical and empirical in nature in which it explores the relationship between the
inflows of FDI and their impact on Indian Economy.

Nature and Sources of Data

The present study is of analytical nature and makes use of secondary data. The
relevant secondary data are collected from the following sources:

Publications of Government of India;

Publications of Reserve Bank of India;
Handbook of Statistics on the Indian Economy, RBI, Various Issues;
Economic Survey, Government of India, Various Issues;
Department of Industrial Policy and Promotion (DIIP);
Central Statistical Organization (CSO);
Investment Report 2009 Published by UNCTAD etc.
Various FDI related journals have also been referred to.

Tools Used for Analysis

The analysis of the data forms the core part of the research. In order to
analyze the data and draw conclusions on this study, various statistical tools like
growth rates, regression and correlation have been used through EXCEL and SPSS
Software.

Period of the Study

The study period is ten years, starting from the year 2003-04 to 2012-13.

Limitations of the Study

The study, as limitations, is confined only to review and analyze the selected
indicators for the period of ten years.
106 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

VI. Analysis and Discussion

1. Inflow of Foreign Direct Investment and Exports

Foreign Direct Investment is playing a very dominant role in the development

of an economy in developing countries. With the help of an increasing trend of FDI
inflows, the country’s export has increased year after year. The year-wise inflows of
FDI secured by the country along with the amounts of exports are furnished in Table
1.
Table-1: Year-wise Inflow of FDI and Export (US$ in Millions)

Years FDI Inflows % of Growth Export % of Growth

2003-04 4,322 -- 63,842.60 --
2004-05 6,051 40.00 83,535.90 30.85
2005-06 8,961 48.09 103,090.50 23.41
2006-07 22,826 154.72 126,414.10 22.62
2007-08 34,843 52.64 162,904.30 28.87
2008-09 41,873 20.17 185,295.00 13.74
2009-10 37,745 -9.85 178,751.40 -3.53
2010-11 34,847 -7.67 251,136.20 40.49
2011-12 46,556 33.60 305,963.90 21.83
2012-13 36,860 -20.82 300,570.60 -1.76
CAGR 23.90% -- 16.76% --

Source: DIPP and Reserve Bank of India, 2013.

The above Table-1 reveals that the FDI inflows and the Exports made by the
country is increasing year after year. The FDI inflows has increased from 4,322 US$
million in 2003-04 to 36,860 US$ million in 2012-13. The increase over the period was
8.5 times. During the study period, the percentage of growth over the previous year
lies between -20.82% and 154.72%. The highest growth rate has been observed
(154.72%) in 2006-07. The lowest growth rate has been registered (-20.82%) in the
year 2012-13.

Further, it is observed from the table that the export has also increased from
63,842.60 US$ million in 2003-04 to 3, 00,570.60 US$ million in 2012-13. During the
study period the percentage of growth over the previous year lies between -3.53% and
40.49%. The highest growth rate has been observed (40.49%) in 2010-11 and the
lowest growth rate (-3.53%) in the year 2009-10.
Ibrahim & Muthusamy 107

Correlation

Correlation analysis was carried out to find out the relationship between the
variables (Foreign Direct Investment. and Exports).

Table-2: Correlations

FDI Export
FDI Pearson Correlation 1 .851**
Sig. (2-tailed) .002
N 10 10
Export Pearson Correlation .851** 1
Sig. (2-tailed) .002
N 10 10

**. Correlation is significant at the 0.01 level (2-tailed).

Table 2 exhibits the relationship between the variables (Foreign Direct

Investment and Exports). Correlation value is 0.851 which is significant at 0.01 levels.
It indicates that as the FDI inflow of the country increases the export also increases.

2. Inflow of Foreign Direct Investment and GDP

Gross Domestic Product (GDP) refers to the market value of all final goods
and services produced within a country in a given period of time. It is often
considered an indicator of growth and standard of living for a country. Foreign Direct
Investment has a close relationship with Gross Domestic Product (GDP) in India.
The year-wise FDI inflows along with GDPs secured by India are seen in Table-3.
108 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

Table-3: Year-wise Inflow of FDI and GDP (Rs. in Crores)

Years FDI Inflows % of Growth GDP % of Growth

2003-04 19,879.47 -- 2,625,819 --
2004-05 27,544.15 38.56 2,971,464 13.16
2005-06 39,764.44 44.37 3,390,503 14.10
2006-07 103,036.56 159.12 3,953,276 16.60
2007-08 139,856.32 35.73 4,582,086 15.91
2008-09 190,488.65 36.20 5,303,567 15.75
2009-10 179,885.12 -5.57 6,108,903 15.18
2010-11 158,595.67 -11.84 7,266,967 18.96
2011-12 218,915.62 38.03 8,353,495 14.95
2012-13 200,393.08 -8.46 9,461,013 13.26
CAGR 25.99% -- 13.68% --

Source: DIPP and Reserve Bank of India, 2013.

Table-3 exhibits the FDI inflows and the Gross Domestic Product (GDP)
achieved by the country. The FDI inflows have increased from Rs.19, 879.47 crores in
2003-04 to 2, 00,393.08 crores in 2012-13. The increase over the period was 10.08
times. During the study period, the percentage of growth over the previous year lies
between -11.84% and 159.12%. The highest growth rate has been observed (159.12%)
in 2006-07 and the lowest growth rate (-11.84%) in the year 2010-11.

The amount of GDP has increased from Rs.26, 25,815 crores in 2003-04 to
Rs.9, 461,013 crores in 2012-13. The increase over the period was 3.6 times. During
the study period, the percentage of growth over the previous year lies between
13.16% and 18.96%. The highest growth rate has been observed (18.96%) in 2010-11
and the lowest growth rate has been observed (13.16%) in the year 2004-05.

3. Inflow of Foreign Direct Investment and Foreign Exchange Reserves

Foreign Exchange Reserves are assets held by central bank i.e Reserve Bank
of India and Monetary authorities. Usually in different reserve currencies, mostly US
Dollar, Euro, Pound Sterling and the Japanese Yen. Foreign Exchange Reserves
should only include Foreign currency deposits and bonds. However, the term in
popular usage commonly also adds Gold reserves, Special Drawing Rights (SDR) and
International Monetary Fund (IMF) reserve positions. The FDI inflows along with
the foreign exchange reserves of the country are provided in Table-4.
Ibrahim & Muthusamy 109

Table-4: Year-wise Inflow of FDI and Foreign Exchange Reserves (Rs. in

Crores)

Years FDI Inflows % of Growth Foreign Exchange Reserves

% of Growth
2003-04 19,879.47 -- 409,129 --
2004-05 27,544.15 38.56 619,116 51.33
2005-06 39,764.44 44.37 676,387 9.25
2006-07 103,036.56 159.12 868,222 28.36
2007-08 139,856.32 35.73 1,237,965 42.59
2008-09 190,488.65 36.20 1,283,865 3.71
2009-10 179,885.12 -5.57 1,259,665 -1.88
2010-11 158,595.67 -11.84 1,361,013 8.05
2011-12 218,915.62 38.03 1,506,139 10.66
2012-13 200,393.08 -8.46 1,588,418 5.46
CAGR 25.99% -- 14.53% --

Source: DIPP and Reserve Bank of India, 2013

Table-4 shows that the FDI inflows and the foreign exchange reserves
secured by the country is increasing trend during the study period. The foreign
exchange reserves have increased from Rs.4,09,129 crores in 2003-04 to Rs.1,588,418
crores in 2012-13. The increase over the period was 3.88 times. During the study
period, the percentage of growth over the previous year lies between -1.88% and
51.33%. The highest growth rate has been observed (51.33%) in 2004-05 and the
lowest growth rate (-1.88%) in the year 2009-10.
Correlation

Correlation analysis was carried out to find out the relationship between the
variables (Foreign Direct Investment. and Foreign Exchange Reserves).
110 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

Table-5: Correlation Analysis

DI FER
FDI Pearson Correlation 1 .969**
Sig. (2-tailed) .000
N 0 10
FER Pearson Correlation 969** 1
Sig. (2-tailed) 000
N 0 10

**. Correlation is significant at the 0.01 level (2-tailed).

Table 5 exhibits the relationship between the variables (Foreign Direct

Investment and Foreign Exchange Reserves). Correlation value is 0.969 which is
significant at 0.01 levels. It indicates that as the FDI inflows of the country increases
the foreign exchange reserve also increases.

VIII. Findings and Suggestions

Major findings of the study are as follows,

 It is found that the compound annual growth rate of flow of foreign direct
investment was 23.90% which is a welcome trend.
 It is found that the compound annual growth rate of export made by the
country was 16.76% which is also a welcome trend.
 It is found that the performance with regard to the trend of flow of foreign
direct investment was better except the year 2012-13.
 FDI inflow has a positive relationship with exports made by the country.
 It is found that the compound annual growth rate of GDP of the country was
13.68% which is a welcome trend.
 It is found that the trend of GDP was better because of the steady increase in
the flow of FDI during the study period.
Ibrahim & Muthusamy 111

 The FDI inflow of the country increases which in turn; the amount of foreign
exchange reserve is also increased. The increase over the period of the foreign
exchange reserve was 3.88 times.
 FDI inflow has a close relationship with the increasing amount of foreign
exchange reserve of the country.

There has been a growing presence of Foreign Direct Investment in Indian

capital market evidenced by an increase in their net sizable investments. This indicates
that Indian capital markets have become vibrant in terms of their composition of
various constituents of the market. In India foreign capital helps in increasing the
productivity of labour and to build up foreign exchange reserves to meet the current
account deficit. Foreign investment provides a channel through which the country can
have access to foreign capital. FDIs have significant impact on the Indian economic
growth in terms of Export, Gross Domestic Product and Foreign Exchange Reserves.
Government should encourage industries to grow to make FDI an attractive avenue
to invest.

IX. Conclusion

Foreign Direct Investment (FDI) is a form of long-term international capital

movement, made for the purpose of productive activity and accompanied by the
intention of managerial control or participation in the management of foreign firm.
Foreign investment is necessary not only to supplement domestic capital but also to
secure scientific, technical and industrial knowledge. In view of this, the government
adopted a liberal attitude by allowing more frequent equity participation to foreign
enterprises, and to accept equity capital in technical collaboration in India. In 1998
and 1999, the Government of India announced a number of reforms designed to
encourage and promote a favorable business environment for investors. The
government also provides many incentives such as tax concessions, simplification of
licensing procedures and de-reserving some industries such as drugs, aluminum, heavy
electrical equipments, fertilizers, etc in order to further boost the FDI inflows in the
country. Thus, foreign investments provide opportunities to host countries to
enhance their economic development and opens new vistas opportunities to home
countries to optimize their earnings by employing their ideal resources.
112 Journal of International Relations and Foreign Policy, Vol. 2(2), June 2014

The world that looks for very attractive foreign investors. Indian economy is
developing very rapidly, it shows unbelievable good indicators and now it has become
the fifth largest economy in the world and one of the most developed economies on
the continent of Asia. Nowadays in India, foreign investment grows in its volumes
and becomes increasingly important.

X. References

Shleifer A. & Vishny R.(1997) ‘ A survey of Corporate Governance’, Journal of Finance,

Vol.52, Issue.2, pp. 737-783.
Vachani, Sushil. 1997. “Economic liberalization’s effect on sources of competitive advantage
of different groups of companies: The case of India,” International Business Review,
vol. 6, no. 2 (April), pp. 165-184.
Stanley Morgan, (2002) ‘FII’s influence on Stock Market’, Journal of Impact of Institutional
Investors on Indian Stock Market, Vol.17, Emerald Group Publishing Limited.
Lin, A. and Chen, C.Y. (2006) ‘The Impact of Qualified FII on Taiwan’s Stock Market’, Web
Journal of Chinese Management Review, Vol.9 No.2, pp 1-27.
Douma, S., Rejie, G. & Kabir, R. (2006) ‘ Foreign and Domestic Ownership, Business
Groups and Firm Performance: Evidence from Large Emerging Market’, Strategic
Management Journal, Vol. 27(7), pp.637-657.
Yew Siew Youg.(2007) ‘Economic Integration, Foreign Direct Investment and
Growth in ASEAN five members’, psarir.upm.edu.my/5038.
Prasanna, P. K. (2008) ‘Foreign Institutional Investors: Investment Preferences in India’,
Journal of Administration And Governance (JOAAG),Vol. 3. No. 2, pp.40-51.
Sumana Chatterjee. (2009) An Economic Analysis of Foreign Direct Investment in India.
Published PhD thesis, Maharaja Sayajirao University of Baroda, Gujarat, India.
Sapna Hooda. (2011) A Study of FDI and Indian Economy. Published PhD thesis, National
Institute of Technology-Deemed University, Kurukshetra, India.
Sarbapriya Ray, (2012) ‘Impact of Foreign Direct Investment on Economic Growth in India:
A Co integration Analysis’, Advances in Information Technology and Management
(AITM), Vol.2 No.1, pp.187-201.
Rahul Dhiman, (2012) ‘Impact of Foreign Institutional Investor on the stock Market’,
International Journal of Research in Finance & Marketing, Vol.2 Issue 4, pp.33-46.
Arshad Muhammad (2012) ‘Impact of Foreign Direct Investment on Trade and Economic
Growth of Pakistan: A Co-integration Analysis’, International Journal of Economic
Research, pp.42-75.

Conference Proceedings

International Conference of Technology and Business Management, March28-30, 2011 on

“Role of FDI in Economic Development of India: Sect oral Growth.
Ibrahim & Muthusamy 113

Web Sites

Research Paper.(Online) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=649852

(Accessed 26 January, 2013)
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January, 2013)
http://www.investorzclub.com/2012/09/fii-investment-inflows-in-india-year.html (Accessed
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http://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=2513 (Accessed on 03.02.13)
http://www.scribd.com/doc/89077601/Role-and-Impact-of-Fiis-on-Indian-Capital-Market
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