Financial Crises and Nexus Between Economic Growth and Foreign Direct Investment

Financial Markets, Institutions and Risks, Volume 2, Issue 1, 2018

(Sumy State University,Ukraine)

Financial Crises and Nexus Between Economic Growth and

Foreign Direct Investment

Debesh Bhowmik

Dr., Retired Principal and Associated with International Institute for Development Studies, Kolkata, Life member, Indian Economic Association, The Indian Econometric Society, Bengal Economic

Association, Ex.Associate Editor-Arthabeekshan-The Journal of Bengal Economic Association,Residence, India.

Abstract

In this paper, author tried to find relation of foreign direct investment inflows with its determinants like growth rate, interest rate, exchange rate, inflation rate, fiscal deficit, openness in India during 1971-2015 through causality, co-integration and vector error correction models. In this paper, it was attempted to explain clearly that how foreign direct investment inflows and outflows have changed during several financial crises in different regions of the world since 1970s in support with a historical analysis over global financial crises. The paper concludes that FDI inflows in India has been catapulting at the rate of 21.56% per year during 1971-2015 and exponentially at the rate of 0.6044% per year significantly. It has four upward structural breaks in 1985, 1994, 2000 and 2006 respectively during the specified period. FDI inflows in India has causal relation uni-directionally with fiscal deficit, and bi-directionally with inflation, exchange rate, interest rate and growth rate during 1971-2015.Johansen co-integration test confirmed that Trace Statistic contains four co-integrating equations and Max Eigen Statistic has three co-integrating equations. VECM is stable, non-stationary and not

good fit for four estimated equations and error corrections for the equations of change of interest rate and inflation rate showed significant with speeds of 23% and 103% per year. The paper also concludes that FDI does not cause Granger financial crises, but financial crises do cause Granger FDI.

Keywords: Foreign Direct Investment, economic growth, financial crises, co-integration, vector error correction.

JEL Classification: C23, C33, F21, F01, O55.

Introduction

Foreign Direct Investment has several dimensions. It affects host countries’ balance of payments and development process. It has long run effects on economic growth and sustainable development which depend on the character of FDI. However, the nexus between growth and FDI is indeterminate since it varies from region to region, country to country and from period to period although the globalization, liberalization and privatization drives accelerated the speed of the nexus towards positive direction irrespective of the distribution of income. Historically, FDI changes from merchants’ capital to multinational investments, from imperialistic attitude to trade domination through economic integration (via financial integration) in international trade and finance.

FDI does not cause crises directly, but it has indirect causes of bubbles and busts. Debt finance through FDI may stimulate debt burden under recession. Financial and banking crises may emerge if FDI in banking sector find losses and shut downs. Yet we cannot avoid the fact that FDI does not Granger cause of financial crises

but financial crises do Granger cause FDI changes which were observed in all the financial crises in the world.

Since the Baring crisis in 1870, India’s FDI was dominated by British imperialism through East India Company whose chief competitors were Dutch East India Company, Danish East India Company, Portuguese East India Company, French East India Company and Swedish East India Company respectively. In 1913, India’s foreign investment stood 35% of GDP and per capita foreign investment was 6 dollar at 1900 US dollar and foreign

direct investment as percent of domestic capital stock was 9%.Presently,India’s FDI inflows is very low in comparison to other countries ,e.g. in 2017 , India’s FDI was accounted as 1.9% of GDP and government of India expects it to rise to 2.5% of GDP with in next five years. In 2017, Mauritius was the top donor country to India comprising 11.47 billion US Dollar followed by Singapore 5.29 billion US Dollar, Netherlands 1.95 billion US Dollar, USA 1.33 billion US Dollar and Germany 934 million US Dollar respectively. As on 2017, Service sector is leading the sectoral distribution of FDI i.e. 8.68 billion US Dollar followed by

telecommunication 5.56 billion US Dollar, Computer hardware and software 3.65 billion US Dollar, Trading..............