Growth in Foreign Trade in Liberalized India: The Relevance of FDI

Abstract

Driven by the need of an economic model that can explain the foreign direct investment (FDI)–export relationship, especially in post-liberalized context, we make a special inquiry on whether FDI has a significant export-promoting impact in India under a time-varying parameter model with vector autoregressive specification. The Johansen’s co-integration test suggests a significant and positive long-run co-movement between FDI and export. The vector error correction model (VECM) confirms a unidirectional long-run causality from export to FDI. However, the Granger causality test establishes a bi-directional causal relationship between these variables in short run. Further, the foreign trade (FT) is found to be a strongly exogenous variable as per the variance decomposition analysis. Again, the impulse response function analysis suggests that the responses generated from a positive shock of FT to FDI and vice versa are small and initially negative, afterward remain steadily positive at a constant level. The study finally recommends the policymakers to channelize the inward-FDI into tradable goods industries rather than only linking it to service sector growth to reap the long-term benefit. In this regard, China’s effort to channelize inward-FDI into manufacturing sectors and the resultant momentous success in export performance can be taken as a classic example for FDI-led foreign trade promotion.

Investigating the Crowding Out Effect of Foreign Direct Investment in South Asian Economies

“…For instance, FDI with a lower inflation rate exhibit positive outcomes (Ezeibekwe, 2020) while a high inflation rate negatively distresses investment in the economy (Musarat et al, 2021). There is another strand of literature, which revolves around the relevance of FDI for liberalization (Jana et al, 2020;Cooray et al, 2014). This could be attributed to the increasing FDI inflows and invariable changes in refining the FDI policy formulation (Reiter, & Steensma, 2010).…”