FDI: Trends and Importance

Section I: Abstract

Public infrastructure, both physical and financial is believed to play important roles in
explaining the heterogeneity of FDI among different states of India. But scarcity of
appropriate state level data poses substantial problems in analysing state wise challenges
and appropriate policy strategies. This paper tries to examine the problem and employ an
unique dataset, which gives the approximate values of FDI inflows of 30 states and Union
Territories. The close examination of the data presents an interesting view regarding the
distribution of FDI in different states and also points out and identifies the factors
responsible for such heterogeneities.

Section II: Introduction

The effectiveness of Foreign Direct Investment (FDI) in pulling the developing world out of
the low level equilibrium traps has been at the centre stage of discussion in various
literatures around the world. The advocates of FDI look at it as a magic-wand to stimulate
growth and generate wealth for the developing nations, providing them the so called “Big
Push”i. Traditional literatures on FDI emphasises that it is an important asset to the
developing countries as it can fulfil their developmental objectives, providing them with
employment, capital, revenue, trade, and technology. But empirically it has been observed
that, since the last three decades FDI has not created much opportunity for the developing
world to flourish. This is because the developing countries around the world lack the
capacity to negotiate mutually beneficial investment agreements with the rest of the world.
Hence, in this era of great global opulence, the harsh reality of scarcity and poverty haven’t
changed even a bit. Internally also, developing nations are now seeing a growing
discrepancy between the values of the substantial foreign investment coming in their country
and the resources available for internal development. In this scenario, as the world economy
is expected to quadruple in the next fifty years, with majority of growth in the FDI sector,
there is growing opportunity for the developing countries to integrate efficiently with the
global market and develop investment patterns in a way so as to maximise their possibilities
of higher growth.
II.I. Some Stylised Facts:

Traditionally India had a tightly controlled capital account since independence. Hence, she
had little opportunities to integrate with the world markets and derive benefits from it. The
capital market saw the light of liberalisation first during the 90s. The 1991 reform
introduced the concept of automatic approvalii, whereby the government empowered the
Reserve Bank of India to approve equity investment up to 51 percent in the 34 “priority”
industries. Subsequently FDI policy of India has been substantially liberalised. Following
the global trend, it has been a lucrative market for foreign investors since the last three
decades as except for a few restricted sectors and sectors subject to a cap below 100%
spelled out in the Foreign Investment policy, Indian market is open to 100% FDI in
automatic routeiii. Thus, from a less than $ 1 billion in the early 1990s, FDI inflows more
than doubled to exceed $ 2 billion in 1995. In the early 2000s, FDI inflows were pegged
between $ 5-7 billion. But after 2005, the reported statistics show a steep increase in
inflows: from $ 20 billion in 2006 to nearly $ 35 billion in 2009. iv In 2017-18, it stands at
$37.36 billionv. The FDI Confidence Index published by AT Kearney, covering 25 top
destinations for FDI, ranks India among the top 6 places in 2003 which it retained till 2012.
Now India is ranked 11th in this surveyvi. Similar upgrading in India’s ranks has also been
reported by the surveys of Japanese Bank of International Cooperation (JBIC) and
UNCTADvii. The rest of the paper is organised in the following manner. Section III takes up
some Literature Review on the subject, Section IV is the Methodology, Section V is the
Analysis and Section VI concludes the paper.

Section III: FDI and Infrastructure in Literature:

From the above stylized facts, it is clear that India is seen as a profitable location for the
MNCs and the recent study regarding the Ease of Doing Businessviii (EODB) substantiates
this claimix. But spatial dynamics of FDI poses an important question in the literature. The
question that arises frequently is that: “Why do few states attract more FDI than the other?”
Similar studies internationally have been done by Fatemi(1984)x, Lins and Servaes(1999)xi
and Denis et al. (2002)xii, which deal with the idea of international diversification of MNCs
in search of profit and in effect lead us to the overarching theme of spatial choice. Together
xiii
with fiscal (tax) incentives and External sector (trade) policiesxiv, provision of
infrastructure has been seen as a potent tool for the state governments to attract FDI. But
this assertion poses significant illusiveness empirically in the literatures. While some FDI
modelsxv predict that an increase in infrastructure uniformly increases FDI inflows, recent
theoretical work incorporating the intermediate goods sector into a general equilibrium
framework predicts that FDI will be insensitive to changes in infrastructure till a threshold is
reachedxvi. The illusiveness can be attributed to two main problems regarding FDI. Firstly,
the availability of accurate data regarding FDI and infrastructure and secondly the problem
that cross country analysis involves innumerable number of unobserved factors 1in various
countries, that have to be controlled for before making statements on the effectiveness of
infrastructural development on FDI.

III.I. Addressing the Problems in Literature

This paper tries to counter these problems by primarily restricting the area of analysis within
India and try to focus on the competitive federalism among the states, especially with
respect to FDI. This analysis is significant pertaining to the fact that firstly, level of
infrastructure in a country is quite persistent with little informative variation over time and
even when infrastructure varies over time, along with itself; it brings about changes in the
structural parameters also. Secondly India gives a perfect setting to analyse this question as
state governments in India, competing with each other to attract FDI, enables us to identify
the effects after accounting for endogenous policy responses to attract FDI.
The second problem is more critical in this study. A close examination to the FDI datasets
available in the various databases highlight the fact that, government and it’s agencies have
paid less than the required attention to ensure that the data is adequate for proper analysis of
FDI inflows and effectiveness of various policies to improve their efficiencies. This paper
overcomes the challenges of datasets by employing a unique dataset at the state/United
Territory level in India to cleanly have a look at the current positions of various states with
respect to FDI and the infrastructural factors that may have attributed to this heterogeneity in
the FDI data among states.

1
These include differences in abundance of natural resources, availability of cheap and
skilled labour, the efficacy of law enforcement and the rule of law, the quality of
bureaucracy, corruption, trade and taxation policies as well as market size
Section IV: Data and Methodology:

Construction of the State wise data:

The FDI data is not available state wise, but is available according to the regional centres of
RBI. Again, the regional offices have the sum of the FDI data of the few states that it
[14]
represents. Hence the state wise data on FDI has been calculated using the GCF ratio of
the states. State wise figures have been arrived at by dividing the FDI for each regional
office in the ratio of GCF for the constituent states.

Indicator Source

RBI Handbook of Indian Statistics,

FDIxvii Ministry of Commerce and Industry,
Government of India.

Annual Survey of Industries (ASI),

GCFxviii Ministry of Statistics and Programme
Implementation, Government of India.

Table 1: Statistics Sources

 Section V: Analysis:

Thus, therefore the FDI data on the states emerges as a weighted identity as following:

𝐹𝐷𝐼𝑖𝑡 = ∑ 𝑤𝑖𝑡 𝐹𝐷𝐼𝑅𝑂𝑗

Where,

𝐺𝐶𝐹𝑖
𝑤𝑖𝑡 =
𝐺𝐶𝐹𝑅𝑂𝑗

𝐹𝐷𝐼𝑅𝑂𝑗 is the total FDI flowing into Regional office ‘j’.

Here,

i = {1, …………….., 30}

j = {1,……………..., 12}

t = {1,………………., 4}

Statewise Statewise Statewise

FDI (FDI at FDI (FDI at FDI (FDI at
Regional Regional Regional
Office Office Office
Statewise FDI (FDI divided at divided at divided at
at Regional Office Statewise Statewise Statewise
divided at Ratio of Ratio of Ratio of
States/ Union Statewise Ratio of GCF) 2013- GCF) 2014- GCF) 2015-
Territories GCF) 2012-13 14 15 16
Andaman &
Nicobar
Islands 10.92911713 10.05253788 0.933190323 3.12605091
West Bengal 22884.5546 26367.3933 14154.24018 54966.39517
Sikkim 298.8562842 211.2941664 480.766633 7229.63878
Bihar 66.94490139 7.152229984 64.05385803 923.0373227
Jharkhand 346.1950986 78.33777002 612.576142 1795.632677
Dadra &
Nagar haveli 50318.67917 10562.94154 21521.47724 0
Daman& Diu 16205.28871 4944.222105 20819.03281 31463.18343
Maharashtra 407066.1221 190438.0264 346993.31 595851.4666
Goa 472.04 1027.1 2112.98 1166.3
Uttarakhand 481.6151813 197.9766333 2144.978953 1410.533364
Uttar Pradesh 1187.954819 1305.543367 4646.391047 3828.276636
Delhi 174895.46 381895.18 422524.42 832884.23
Haryana 1321.287697 3417.455735 878.1882906 1308.444513
Himachal
Pradesh 335.3107839 479.380995 60.46738885 195.0991775
Chandigarh 28.69441679 28.61460638 962.3186688 2.195256222
Punjab 859.9871025 1696.448664 438.5056517 266.2010532
Gujarat 26762.64 52820.59 94157.44 146669.72
Karnataka 55529.65 114216.18 212548.46 267907.46
Kerala 3895.66 4109.14 14183.55 5889.42
Chhattisgarh 5133.968841 3884.855345 2769.711312 2736.429558
Madhya
Pradesh 6948.431159 3197.064655 3239.058688 2445.430442
Manipur 0.262164907 0.209800057 0.274145152 4.877312453
Meghalaya 131.1318151 4.4113996 9.590008518 87.86672639
Nagaland 0 0.087335047 0.074208717 2.205406016
Assam 139.1640432 32.77415596 275.1226788 554.8596449
Tripura 1.951976786 0.73730934 1.68731403 6.981619306
Arunachal
Pradesh - 1.881644771 5.059290945
Rajasthan 7137.99 2330.17 32369.89 3315.95
Odisha 2851.84 2882.18 555.01 361.56
Tamil Nadu 148705.7614 122240.929 229923.1741 293417.6547
Puducherry 3812.818591 3713.071005 3682.405923 4392.215258
Telangana 20322.01098 13833.46167 40468.45874 34091.95471
Andhra
Pradesh 42580.37902 26401.62833 42786.67126 69062.96529
Jammu and
Kashmir 14.45 245 114.13
values in Mizoram values are
million missing all
throughout the
data set

Source: Computed by authors

In doing so, the analysis has some degree of inefficiency also. It has to be kept in mind that
in many cases FDI funds can be used to cover deficits in an economy or to pay off loans by a
company. Thus it is not necessary that FDI is always included in GCF calculations. Also
some studiesxix conclude that the relationship between FDI and GCF is misleading in some
case without accounting for the motivation of investments. But, the study is based on the
fact that as GCF is a good indicator of the capabilities of Indian states in case of domestic
capitalxx; hence it should be a good indicator of the capacity of states in absorbing FDI.

Section VI: Conclusion

Findings from the Study:

The study here finds a clustering of data among the states/Union Territories. While high
performing states like Maharashtra, Delhi, Tamil Nadu and Karnataka remain in the top spot
in all the years (2012-2016), the low performing states like Manipur, Nagaland or
Chandigarh have also not improved in this time period substantially. There are various
reasons to this clustering of FDI found in various literatures.

The product life cycle hypothesis of Vernon (1966)xxi suggests that, the foreign firms prefer
some location over others, due to the cost-advantages of that particular location. The models
of Kindleberger (1969)xxii, Hymer (1976)xxiii and Caves (1982)xxiv asserts that intangible
assets (e.g., brand name, protection of patent, managerial skills, etc), lesser cost of capital,
superior management, better advertising, promotion and distribution network, access to raw
materials, economies of scale, efficient transportation infrastructure, substantial R&D
investment in the home country etc. motivate a firm in investing abroad. The eclectic theory
of Dunning (1977)xxv explains the firm-specific advantages of going abroad. Krugman
(1996xxvi, 1998xxvii) holds market size, external economies, knowledge spill overs, input
costs and pollution responsible for the special heterogeneity. Other than these market
potential, low labor costs, skilled workforce, corporate tax rates relative endowments, legal,
political and economic environment and distance from markets have significant impact on
FDI decisions.

Regarding the study, if we look at Maharashtra, we will see that historically, it has been of
the most industrialized state in the country. Mumbai is known as the financial hub of India,
while Pune is perceived as a major educational centre in recent times. Further the state has
always been a leader among all states with regards to infrastructure. Also, JNPT (Jawaharlal
Nehru Port Trust of India) provides effective communication network with market of south,
North & west India. The state has adopted the Special Economic Zone (SEZ) Policy in 2006.
As per the economic survey of Maharashtra 2011-2012, number of approved SEZs in the
state are 98 mostly in Konkan, Pune, Nagpur regions. All these factors contribute in
attracting FDIs into the state.

In this context it is also notable in this context, Delhi, one of the highest performers among
the Indian states, gets most of the investments because of the quality of governance and
improved infrastructure in the state. The tertiary sector of the state, including services like
commercial trade, business services, tourism and hospitality, transportation, communication,
banking and insurance, real estate, public administration, etc. has contributed to the major
development of Delhi.

Like the North and West Indian states South Indian states also feature in the top five regions
every year with respect to FDI flows. The states like Tamil Nadu, Andhra Pradesh etc.
attract major FDI flows every year. There are mainly two reasons for such huge
development. One is the rapid development of services sector, like tourism and IT. The
second one is the state policies regarding SEZ, reduction of stamp duties, massive upheaval
of power sectors etc.

But, compared to the other states East and North East India have been slow in receiving FDI
flows. There are a number of reasons for this. The common problems in these regions are
scarce infrastructure, unskilled labour and inefficient governance. There are socio-economic
problems and regional diversity in terms of terrains in North-Eastern states. The government
here also have showed very little intent regarding the promotion of various sectors here that
could have brought rapid foreign investment.xxviii

Thus the “agglomeration” factor has emerged as one of the most important determinants of
regional distribution of FDI flows within a country. Agglomeration economies emerge due
to some positive externalities in collocating near other economic units due to the presence of
xxix
knowledge spillovers, specialised labor markets and supplier network . Foreign
investors are inclined to favour locations that could minimise information costsxxx. A
common finding in recent studies is that regions with a relatively higher GCF are more
likely to attract further investments, which confirms the importance of positive
agglomeration externalities.
Endnote
i
This theory is an investment theory which stresses the conditions of take-off. The argumentation is quite
similar to the balanced growth theory but emphasis is put on the need for a big push. The investments should
be of a relatively high minimum in order to reap the benefits of external economies. Only investments in big
complexes will result in social benefits exceeding social costs. High priority is given to infrastructural
development and industry, and this emphasis will lead to governmental development planning and influence.
ii
Entry of FDI in India happens through two routes- automatic and approval routes. Under
the Automatic Route, the foreign investor or the Indian company does not require
any approval from the Reserve Bank or Government of India for the investment.
The approval route FDI is allowable in all sectors and activities specified under
the consolidated FDI policy.
iii
Arvind Panagariya, "India: The Emerging Giant." New York: Oxford University Press,
2008.
iv
UNCTADSTAT
v
“Annual Report, Reserve Bank Of India”. Reserve Bank of India, 2018.
vi
Annual Report. A.T. Kearney, 2019.
vii
World Investment Report. UNCTAD, 2018.
viii
Economies are ranked on their ease of doing business, from 1–190. A high ease of doing
business ranking means the regulatory environment is more conducive to the starting and
operation of a local firm. The rankings are determined by sorting the aggregate scores on 10
topics, each consisting of several indicators, giving equal weight to each topic.
ix
World Bank Database, 2018
x
A. Fatemi, “Shareholder Benefits from Corporate International Diversification” The
Journal of The American Finance Association, 1984
xi
K. Lins, H. Sarvaes, “International Evidence on the Value of Corporate Diversification”
The Journal of The American Finance Association, 2002
xii
DK. Denis “Global Diversification, Industrial Diversification, and Firm Value”. The
Journal of Finance. 2002
xiii
Bruce A. Blonigen, "A Review of the Empirical Literature on FDI Determinants ."
University of Oregon and NBER, 2005.
xiv
David G. Hartman, "Tax policy and foreign direct investment." National Bureau of
Economic Research, 1981.
xv
. Philip Martin, Carol Ann Rogers. "Industrial Location and Public Infrastructure."
Journal of International Economics, 1995.

xvi
. Jan I Haaland, Ian Wooton. "International Competition for Multinational Investment."
Scandinavian Journal of Economics, 1999.
xvii
FDI is expressed in million Rupees. We have assumed the FDI inflow via the New Delhi
Office to be that of NCR and values of FDI for UP and Haryana has been calculated from
the regional offices at Kanpur and Chandigarh respectively for their proximity. State wise
figures have been arrived at my dividing the FDI for each regional office in the ratio of GCF
for the constituent states. Mizoram values are missing all throughout the data set. FDI value
for Arunachal Pradesh was not estimated in 2012-13 and 2013-14.
xviii
Figures are in million Rupees. GCF (2012-13) value for Nagaland has been assumed to
be zero as the original values are negative. GCF (2014-15) value for Delhi has been taken
from Delhi govt. website, of GFCF, as the original value from RBI website was negative.
GCF(2015-16) value for Daman an Diu has been taken to be zero due to negative original
value.
xix
. W Hejazi, P Pauli. "Motivations for FDI and domestic capital formation." Journal of
International Business Studies, 2003.
xx
Kumarjit Mandal, Samrat Roy. "Foreign Direct Investment and Economic Growth: A
Cross-Country Exploration in Asia using Panel Co-Integration Technique ."

Vernon R. “International Investment and International Trade in the Product Cycle”. The
xxi

Quarterly Journal of Economics.1966

xxii
Kindleberger Charles P. “American Business Abroad”. Thunderbird International
Business Review. 1969

HYMER, S. H. “The International Operations of National Firms: A Study of Direct

xxiii

Foreign Investment”. Cambridge. MIT Press. 1976

Caves, R. E. “Multinational Enterprise and Economic Analysis”. Cambridge:

xxiv

Cambridge University Press. 1982

xxv
Dunning J.H. “Trade, Location of Economic Activity and the MNE: A Search for an
Eclectic Approach.” Ohlin B., Hesselborn PO., Wijkman P.M. (eds) The International
Allocation of Economic Activity. Palgrave Macmillan, London. 1977
xxvi
Krugman P. “The Country is Not a Company” Harvard Business Review. 1996

Krugman P.“It’s Baaack: Japan's Slump and the Return of the Liquidity Trap”. MIT
xxvii

University Press. 1998

xxviii
Shodhganga. Chapter 4. “Regional Distribution of FDI in India”
xxix
Krugman, Paul. "Increasing Returns and Economic Geography ." Journal of Political
Economy, 1991.
xxx
Chakraborty R. et al. “Infrastructure and FDI: Evidences from district level data in
India”. 2012