FDI IN INDIA: DETERMINANTS AND

ITS COMPARISON WITH CHINA

PROJECT REPORT

Submitted to:

Prof.D.T.Rao

Indian Institute of Management, Lucknow

Submitted by:

Group-8

Rahul Paith(fpm11009), Manoj Singh(pgp26288), Deshraj Bhatt(pgp26276),

Lokendra Kaushik(pgp26284), Manash Saikia(pgp26287), Thushara
Reddy(abm07018)

Section E
Any investment flowing from one country to another country is foreign
investment. To define it in simple terms we can say that any financial investment
by which a person or an entity acquires a lasting interest in, and a degree of
influence over, the management of a business enterprise in a foreign country is
foreign investment.

Indian Government classifies foreign investment in the following form:

• Foreign direct investment (FDI)
• Foreign institutional investment (FII)
• Non-resident Indian (NRI) investment
• Person of Indian Origin (PIO) investment

Country wise break up analysis of FDI in India

The major countries contributing to the FDI inflow in India are USA, UK and
Singapore etc. Mauritius is the largest contributor in the cumulative FDI flow
during the period of 2000-2008 with a 44% share of the pie. USA follows with
8.38%. UK and Singapore with 7.43% and 7.19% contribution to the FDI inflow
respectively follow.

Study of FDI flow in different sectors

The sectorial shares of FDI inflows have fluctuated significantly in the recent
years. Sectors like Services, telecommunications, housing and real estate,
etc. are the most significant recipients of FDI inflows. The pie chart shows the
contribution of top 10.

Study of FDI flow in different states

The FDI inflow is highly skewed in India. The Mumbai regional office accounts for
34 percent of the total FDI inflows which covers states of Maharashtra and Dadra
Nagar Haveli.This is followed by Delhi office which covers states of Delhi,UP and
Haryana and accounts for 20 percent of the total FDI inflows. The other states
account for the remaining FDI inflows which shows the high skewness in the
distribution.

Determinants of overall FDI in the economy:

Growth Prospects and Size

One of the most important determinants of foreign direct investment is the size
as well as the growth prospects of the economy of the country where the foreign
direct investment is being made. It is normally assumed that if the country has a
big market, it can grow quickly from an economic point of view and it is
concluded that the investors would be able to make the most of their
investments in that country.

Population
The population of a country plays an important role in attracting foreign direct
investors to a country. In such cases the investors are lured by the prospects of a
huge customer base.
Now if the country has a high per capita income or if the citizens have
reasonably good spending capabilities then it would offer the foreign direct
investors with the scope of excellent performances.

Human Capital
The status of the human resources in a country is also instrumental in attracting
direct investment from overseas. There are certain countries like China that have
taken an active interest in increasing the quality of their workers. Inexpensive
labor force is also an important determinant of attracting foreign direct
investment. The BPO revolution, as well as the boom of the Information
Technology companies in India has been a proof of the fact that inexpensive
labor force has played an important part in attracting overseas direct
investment. Infrastructural factors like the status of telecommunications and
railways play an important part in having the foreign direct investors come into a
particular country.

Natural Resources
If a particular country has plenty of natural resources it always finds investors
willing to put their money in them. A good example would be Saudi Arabia and
other oil rich countries that have had overseas companies investing in them in
order to tap the unlimited oil resources at their disposal.

Real Exchange Rate

Any depreciation in the currency of a country will make the country more
favorable for foreign investments.

Relationship of Foreign Investment with Macro Economic Factors

1. Foreign investment in India and India’s GDP
FDI shows a strong linear correlation with the GDP of India. R2 value of 0.784
shows the strength of the correlation between the two parameters.

2. FDI and Wholesale Price Index Rsquare = 0.664

FDI shows a fair correlation with WPI .

3.FDI and population Rsquare = 0.554

FDI is fairly related with population growth although the relation is mediocre.

4. FDI and real exchange rate Rsquare = 0.33

FDI does not show a good linear fit with the exchange rates . It hints at non-
linear relation as the linear fit is not good.

Growth Model:

GDP depends on several factors. A regression run was done to understand this
dependability on three factors viz FDI,consumption and net exports for India and
China.
The results show the following fit.

India: GDP = 0.319FDI -0.511NX + 1.138C +a1

China : GDP = 0.204FDI + 0.152NX + 0.928C +a2

a1,a2 are the respective error terms of regression

As can be seen , GDP of india is more effected by FDI as compared to China due
to higher value of the regression coefficient.at the same time , consumption
drives Indian GDP more than that for China.

India vs. China- FDI Approach

To study the trend of FDI and its determinants two largest countries are studied
and rapidly emerging economies as an example of studying the phenomenon of
foreign investment inflow. China has grown rapidly and India has trailed behind.
China got $88.2 billion dollars in 2010 in FDI and India did not even get $34.58
billion last year in FDI.

India despite being the largest democracy in the world has lagged behind due to
its focus on services and specialized skill based relatively small manufacturing
model in contrast to China. Indian growth model has been based on IT, ITES, and
skilled manufacturing which is dependent on the availability of human skill and
capital in an emerging market. Indian growth has been positively related to its
human capital stock. Also, the size of the Indian economy, its growth rate, its
political stability, exchange rate volatility, and the extent of corruption have
affected foreign direct investment in the country in last fifteen years.

China opened its economy in 1978 and within 25 years grew at a rapid face to
become one of the largest economies in the world with a promise of being the
number one economy in the world in next thirty-forty years. This trend is being
analysed and found statistical evidence that Chinese growth has been due to its
adopting a congenial business climate comprising of furthering structural
changes in the economy, creating strategic infrastructure on its coastal boundary
by developing Special Economic Zones, and by evolving strategic policy
initiatives. These initiatives include providing economic freedom for companies
to grow, creating openness in trade related policies to increase export and
import across its borders, formulating flexible labour laws to allow market
oriented corporate structures, and engaging the Diaspora to develop its
economy. The study also found that the size of Chinese economy, its annual
growth rate, and political stability have also played a role in attracting Foreign
Direct Investment over last twenty-eight years.

India can learn lessons from China and create congenial business climate in the
country to catch up with China. India can let the ‘endurance seeking’ FDI of
TNC’s enter its borders as TNC’s try to move ‘linear synergistic FDI’ to benefit
from exporting and marketing opportunity in emerging markets. Given other
factors as constant TNC’s would like to manufacture in India six times more as
compared to China due to the exchange rate advantage and the relative
strength of US dollar to Indian rupee as opposed to Chinese Yuan. If India can
create structural changes at a faster pace it might attract more FDI and grow
rapidly. India can also develop strategic infrastructure on its coast (East) by
growing large incentive oriented SEZ’s based on its demographic realities and by
employing large population in labour oriented export manufacturing scenario, it
can balance its service sector growth and grow holistically. Creating economic
freedom for increasing private sector and TNC participation, opening trade to
become more global in its outlook, formulating flexible labour laws to attract free
market determined organizational structures, and engaging Indian Diaspora in its
economic activity- can help India in becoming a global player in the world
economy.

Emerging markets can learn from the Chinese and Indian story and attract
foreign direct investment to grow their economies and benefit from the current
wave of globalization.

Managerial Implications

The study might help the in creating the right congenial business climate so that
maximum FDI can flow into India and India can grow rapidly. The study expects
to help managers in understanding drivers of growth in different emerging
markets and be able to pinpoint areas where investments can be made by TNC’s.