Advances in Information Technology and Management (AITM) Vol. 2, No.

1, 2012, ISSN 2167-6372 Copyright World Science Publisher, United States www.worldsciencepublisher.org

187

Impact of Foreign Direct Investment on Economic Growth in India: A Co integration Analysis

Sarbapriya Ray
Shyampur Siddheswari Mahavidyalaya, University of Calcutta, India. Email: worldsciencepublisher@gmail.com Abstract: The role of FDI in the growth process has been a burning topic of debate in several countries including India. This paper is an attempt to analyze the causal relationship between Foreign Direct Investment (FDI) and economic growth in India and tries to analyze and empirically estimate the effect of FDI on economic growth in India, using the cointegration approach for the period, 1990-91 to2010-11. The empirical analysis on basis of ordinary Least Square Method suggests that there is positive relationship between foreign direct investment(FDI)investment and GDP and vice versa. The unit root test clarified that both economic growth and foreign direct investment were found to be integrated of order one using the Kwiatkowski, Phillips, Schmidt and Shinn (KPSS) test for unit root only. The cointegration test confirmed an existence of long run equilibrium relationship between the two as confirmed by the Johansen cointegration test results. The Granger causality test finally confirmed the presence of uni-directional causality which runs from economic growth to foreign direct investment. The error correction estimates gave evidence that the Error-Correction Term is statistically significant and has a negative sign, which confirms that there isnt any problem in the long-run equilibrium relation between the independent and dependent variables. For FDI to be a noteworthy provider to economic growth, India would do better by focusing on improving infrastructure, human resources, developing local entrepreneurship, creating a stable macroeconomic framework and conditions favourable for productive investments to augment the process of development. Keywords: FDI; Economic Growth; India; cointegration; granger causality.

1. INTRODUCTION: The role of FDI in the growth process has been a burning topic of debate in several countries including India. FDI is a vital ingredient of the globalization efforts of the world economy. The growth of international production is driven by economic and technological forces. It is also driven by the ongoing liberalization of Foreign Direct Investment (FDI) and trade policies. One outstanding feature of the present-day world has been the circulation of private capital flow in the form of foreign direct investment (FDI) in developing countries, especially since 1990s. Since the 1980s, multinational corporations (MNCs) have come out as major actors in the globalization context. Governments around the world in both advanced and developing countrieshave been attracting MNCs to come to the respective countries with their FDI. This experience may be related to the broader context of liberalization in which most developing and transition countries have moved to market-oriented strategies. In this context, globalization offers an unparalleled opportunity for developing countries like India to attain quicker economic growth through trade and investment. In the period 1970s, international trade grew more rapidly than FDI, and thus international trade was by far than most other important international economic activities. This situation changed radically in the

middle of the 1980s, when world FDI started to increase sharply. In this period, the world FDI has increased its importance by transferring technologies and establishing marketing and procuring networks for efficient production and sales internationally (Shujiro Urata, 1998). FDI flows comprise capital provided by foreign investors, directly or indirectly to enterprises in another economy with an expectation of obtaining profits derived from the capital participation in the management of the enterprise in which they invest. The foreign investors acquire ownership of assets in the host country firms in proportion to their equity holdings. This is the empirical definition of FDI adopted by many countries to distinguish it from portfolio flows. According to International Monetary Fund (IMF), FDI is defined as an investment that is made to acquire a lasting interest in an enterprise operating in a economy other than that of the investor The investors purpose is to have an effective voice in the management of the enterprise (IMF,1977).FDI is the process by which the residents of one country (the source country) acquire the ownership of assets for the purpose of controlling the production, distribution and other productive activities of a firm in another country (the host country). Since the 1997 East Asian financial crisis, the relationship between Foreign Direct investment (FDI),

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exports and economic growth has gained importance and attention among policy makers and researchers. The concept of Investment led Economic Development has promoted the idea that the outward and inward FDI position of a country is linked to its economic development relative to the rest of the world. It recommends that the countries changes through five different stages of development. These stages are being classified according to the propensity of the countries to the outward and/or inward investors (Dunning and Narula, 1999). This propensity, in turn, depends on the extent and pattern of the ownershipspecific advantages of domestic firms, its location advantages and the degree of utilization of the ownershipspecific advantages by the domestic and foreign firms in the internationalization of markets. Foreign Direct Investment (FDI) has appeared as the most significant source of external resource flows to developing countries over the years and has become a significant part of capital formation in these countries, despite their share in global distribution of FDI continuing to remain small or even declining. The effects of FDI in the host economy are usually believed to be increase in the employment, augment in the productivity, boost in exports and amplified pace of transfer of technology. It facilitates the utilization and exploitation of local raw materials, introduces modern techniques of management and marketing, eases the access to new technologies, foreign inflows can be used for financing current account deficits, finance flows in form of FDI do not generate repayment of principal and interests (as opposed to external debt) and increases the stock of human capital via on the job training. The effect of FDI on growth rate of output was constrained by the existence of diminishing returns of physical capital. Consequently, FDI could only put forth an effect on the level of output per capita, but not on the growth rate. In other words, it was unable to modify the growth of output in the long run. In the context of the new theory of Economic Growth, FDI is considered as an engine of growth of mainstream economies. As noted by the World Bank (2002), several recent studies concluded that FDI can promote the economic development of the host Country by promoting productivity growth and export. However, the exact relationship between foreign multinational corporations and their host countries varies considerably between countries and among industries. The characteristics of the host country and the policy environment are important determinants of net benefit of FDI. In view of the above discussion, this discussion provides rich insight into the relationship between FDI and Growth. Therefore, this paper is an attempt to analyze the causal relationship between Foreign Direct Investment (FDI) and economic growth in India.The present paper tries to analyze and empirically estimate the effect of FDI on economic
Year 1991-92

growth in India, using the cointegration approach for the period, 1990-91 to2010-11. 2. CURRENT SCENARIO OF FDI INFLOW IN INDIA: Since economic reforms initiated in 1991, Government of India has taken many programs to magnetize FDI inflows, to improve the Indian economy. An important objective of promoting FDI in India and other developing countries has been to promote efficiency in production and increase exports. However, any increase in equity stake of the foreign investors in existing joint ventures or purchase of a share of equity by them in domestic firms would not automatically change the orientation of the firm. That is, the aim of FDI investors would be to benefit from the profit earned in the Indian market. As, a result, in such cases FDI inflows need not be accompanied by any substantial increase in exports, whether such investment leads to modernization of domestic capacity or not. Therefore, it is a challenge for a developing country like India to channelize its capital inflow through FDI into a potential source of productivity gain for domestic firms. As a result, India has received total FDI of US$ 180,034 million from the year 1990-91 to 2009-10 which is due to the initiatives taken by the Government of India in attracting FDI inflows in India. The FDI inflows have shown a rising trend from 1991-92 to 1997-98 owing to the sincere programmes of structural liberalization and openmarket reforms. The rise in flows of FDI till 1997 was due to not only of the liberalization policy but also due to the sharp expansion in the global scale of FDI outflows during the 1990s. Another causal factor may have been the recovery of the Latin American economies, which had begun to emerge from the Debt Crisis of the 1980s. Then after during 1998-99 and 1999-00 there was decline in FDI inflow which was due to the decline in industrial growth rate in the economy and also due to the result of the East Asian Financial Crisis. But again in the next following year, foreign investment started to bounce back. During 2002-03 and 2003-04, again there was fall in flow of foreign direct investment which was due to the cast of Global Recession on the Indian economy. The FDI Equity inflows during the five years 2005-06 to 2009-10 showed a massive increase of more than seven times than those of the previous years 1991-92 to 1999-00 and 2000-01 to 200405. This increase was due to the revised FDI Policy in March 2005, an important element of the policy was to allow FDI up to 100% foreign equity under the automatic route in townships, housing, built-up infrastructure and construction-development projects. The year 2005 also witnessed the enactment of the Special Economic Zones Act, which entailed a lot of construction and township development that came into force in February 2006.

Table 1: Statement showing FDI Inflows in India (Amount in US $ million) FDI Inflows Annual Growth Rate (%) 129 33

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1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Total

315 586 1314 2144 2821 3557 2462 2155 4029 6130 5035 4322 6051 8961 22826 34835 35180 37182 180034

144 86 124 63 31 26 -30 -12 87 52 -17 -14 40 48 155 52 1 5

Source: FDI Statistics, DIPP, Ministry of Industry and Commerce as cited in Anitha& Dr. K. Maran (2011)

FDI inflows show a skewed pattern in terms of their originating destinations. Between 1991 and 2005, investment of Top 10 countries accounted for about 80 percent of total FDI. The share of top investing countries has increased to 91 percent during the period 2005-09. The major investing countries in India are Mauritius, USA, Singapore, UK, Netherlands, Japan, Germany and others as shown in table. According to the data relating to the period 1991-2005, Mauritius has been the biggest source of FDI. This could be because of common cultural patterns in both the countries and also close political and bilateral ties.
S.No. 1 2 3 4 5 6 7 8 Country Mauritius Singapore USA UK Cyprus Netherlands Japan Germany

Mauritius has low rates of taxation and an agreement with India on double tax avoidance regime. For these reasons, some MNCs set up companies in Mauritius before investing in India. Apart from Mauritius, the US is the second major investor in India from 1991 to 2004 contributing about 16% of total infIow. The reason could be that both countries have close relations and US is the largest trading partner of India and a broad Indian community lives in it. More interestingly, from the period 2005-09, Singapore replaces US as the second major investor in India.

Table2: Share of Top 10 Investing Countries in India (%) Aug.1991-Dec.2000 2001-2004 2005-2009 31.51 2.76 20.10 5.44 0.20 5.19 7.41 5.61 38.81 2.22 14.36 7.80 0.18 9.48 7.32 4.13 49.62 11.33 7.28 5.64 4.41 3.83 3.22 2.61

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9 10

UAE France Sub-Total Others Total FDI Inflows

0.08 2.59 80.90 19.10 100

0.66 3.22 88.19 11.81 100

1.75 1.24 90.80 9.20 100

Source: SIA Newsletter, as cited in Anitha& Dr. K. Maran(2011)

In recent years, India is losing its attraction as FDI destination. From a position of 8th rank in2009 India has fallen to14th position as country attracting largest FDI, according to World Investment Report 2011 by United Nations Conference on Trade and Development (UNCTAD). Developing countries like China, Hong Kong, Singapore, Thailand, Taiwan, Malaysia etc. are attracting a higher FDI inflow than India. A number of studies and reports highlight the weakness of India as a falling FDI destination. In the latest study from World Bank Ease of Doing Business in India 2011 India is ranked as 134 out of 183 countries. 3. REVIEW OF EXISTING LITERATURE: The FDI-growth nexus is evidently identified by the neoclassical growth models. The neoclassical growth model considers technological progress and labour force as exogenous, and thus argues that FDI increases level of income only while it has no long run growth effect if it does not expand technology. Long run growth can only be increased through technological and population growth and if FDI positively influences technology, then it will be growth advancing (Solow 1956). Somwaru and Makki (2004) indicate that according to recent endogenous growth theory, FDI can be growth advancing if it results in increasing returns in production through spillover and technological transfers via diffusion processes. In addition, Easterly et al. (1995) argue that technology transfer depends on the diffusion process and that can take place through four modes: transfer of new technologies and ideas; high technology imports; foreign technology adoption; and level of human capital. Findlay (1978) presents the contagion effect of managerial practices and advanced technology introduced by foreign firms on the host countrys technology. Yangruni Wu (1999) emphasizes the role of the learning process through FDI in the growth of a country. In contrast, Charkovic and Levine (2002) claim that FDI creates the crowding out effect on domestic capital and hence the effect of FDI on growth is either insignificant or negative. In addition, other studies reason that causality can be the other way and market seeking FDI tends to serve the growing economies. Similarly, multinational corporations are attracted towards growing and productive economies. Therefore, this bi-directional behaviour between FDI and GDP can create simultaneity bias between the two variables. Further, there is the similar two-way causality

discussion between exports and GDP. The first is the export led growth hypothesis, while the other equally appealing hypothesis is that output growth causes export growth. Finally, there is a same bi-directional argument in the case of FDI and the export nexus. Petri and Plummer (1998) argue that it is not clear whether FDI causes exports or exports cause FDI. Then there are other concerns such as specified by Gray (1998) regarding market seeking (substitute) FDI or efficiency seeking (complement) FDI. Furthermore, Kjima (1973) analyze whether FDI is trade oriented or anti trade oriented. Vernon (1966) explores whether FDI is at the early product life cycle stage (substitute) or at the mature stage (complement). The theoretical and empirical literature on the growth effects of FDI by transnational corporations (TNCs) on host countries is enormous. Recent researches attempt to analyze the impacts of FDI on host countrys economy and competitiveness of firms, empirical results show that the consequence is different. Some studies indicate that FDI can stimulate the economic growth through spillover effect such as new technologies, capital formulation, the expansion of international trade and the development of human capital (labor skills and employment) (Alguacil et al., 2002; Baharumshan and Thanoon, 2006; Balasubramanyam et al., 1996, 1999; Bende-Nabende and Ford, 1998; Borensztein et al., 1998; Chakraborty and Basu, 2002; De Mello, 1997, 1999; Liu et al., 2002; Wang, 2005). However, others point put that FDI can offset then economic growth (Bende-Nabende et al., 2003; Carkovic and Levine, 2005). Bende-Nabendem et al. (2003) found that FDI in some countries had a negative relation with economic growth. Hsiao and Hsiao (2006) assert that exports increase FDI by paving the way for FDI by gathering information of the host country that helps to reduce investors. transaction costs. Also FDI may reduce exports by serving foreign markets through establishment of production facilities there. Balasubramanyam et. al. (1996) tested the hypothesis that exports promoting (EP) FDI in countries like India confer greater benefit than FDI in other sectors. They have used production function approach in which FDI is treated as an independent factor input in addition to domestic capital and labour. As FDI is a source of human capital accumulation and development of new technology for developing countries, FDI captures such externalities as learning by watching and/or doing and various spillover effects. Exports are also used as an additional factor input

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in this production function. Once FDI enters a country, some of the erstwhile imports become domestic products. Hence, their output becomes a part of GDP which needs consideration as a part of output or growth effect of FDI. In their model, real GDP depends on labour, domestic capital stock, foreign capital stock, exports, and technical progress through time. Time is an all inclusive proxy variable which captures the influence of all factors, including changing technology, that are impounded under the assumption of ceteris paribus. This is why time is defined as the parameter of functional shift. Thus, it is erroneous to interpret the coefficient of T as representing change in technology alone. However, it has become a customary to treat time as a representative of technological change. Borensztein et al. (1998) examine absorptive capacity of recipient country, which is measured by stock of human capital required for technological progress; it takes place through 'capital deepening' associated with new capital goods brought into an economy by FDI. It has been found out that the fructification of growth effect of FDI requires adequate infrastructure as a pre-requisite. A comprehensive study by Bosworth and Collins (1999) provides evidence concerning the effect of capital inflows on domestic investment for fifty-eight developing countries during 197895. The authors distinguish among three types of inflows: FDI, portfolio investment, and other financial flows (primarily bank loans). It has been found out that an increase of a dollar in capital inflows is associated with an increase in domestic investment of about fifty cents. This result covers significant differences among different types of inflows. Foreign direct investment appears to bring about close to a one-for-one increase in domestic investment; there is virtually no discernible relationship between portfolio inflows and investment (little or no impact), and the impact of loans falls between those of the other two. These results hold both for the fifty-eight-country sample and for a subset of eighteen emerging markets. An additional striking feature of FDI flows that was noted in previous literature is that the share of FDI in total inflows is higher in riskier countries, as measured either by countries credit ratings for sovereign (government) debt or other indicators of country risk. There is also some evidence that the FDI share is higher in countries where the quality of corporate governance institutions is lower. One explanation for this is that FDI is more likely, compared with other forms of capital flows, to take place in countries with missing or inefficient markets. In such settings, foreign investors will prefer to operate directly instead of relying on local financial markets, suppliers, or legal arrangements. According to the study done by Pradeep Agrawal (2000) on economic impact of foreign direct investment in south Asia by undertaking time-series, cross-section analysis of panel data from five South Asian countries; India, Pakistan, Bangladesh, Sri Lanka and Nepal, that there exist complementarily and linkage effects between foreign and national investment. Further he argues that, the impact of FDI inflows on GDP growth rate is negative prior

to 1980, mildly positive for early eighties and strongly positive over the late eighties and early nineties. Most South Asian countries followed the import substitution policies and had high import tariffs in the 1960s and 1970s. These policies gradually changed over the 1980s, and by the early 1990s, most countries had largely abandoned the import substitution strategy in favor of more open international trade and generally, market oriented policies (Pradeep Agrawal, 2000). But the analysis of Brecher and Diaz-Alejandro (1977), gives us evidence that foreign capital can lower the economic growth by earning excessive profits in a country with severe trade distortions such as high tariffs. Maria Carkovic and Ross Levine (2002) also concluded in their econometric study on FDI and GDP growth that the exogenous component of FDI does not exert a robust, independent influence on growth. FDI inflows had a significant positive effect on the average growth rate of per capita income for a sample of 78 developing and 23 developed countries as found by (Blomstrm teals, 1994). However, when the sample of developing countries was split between two groups based on level of per capita income, the effect of FDI on growth of lower income developing countries was not statistically significant although still with a positive sign. They argue that least developed countries learn very little from MNEs because domestic enterprises are too far behind in their technological levels to be either imitators or suppliers to MNEs. Borensztein, et al.,( 1998) found that the effect of FDI on host country growth is dependent on stock of human capital. They infer from it that flow of advanced technology brought along by FDI can increase the growth rate only by interacting with countrys absorptive capability. They also find FDI to be stimulating total fixed investment more than proportionately. In other words, FDI crowds-in domestic investment. However, the results are not robust across specifications. A recent study by Banga (2005) demonstrates that FDI, trade and technological progress have differential impact on wages and employment. While higher extent of FDI in an industry leads to higher wage rate in the industry, it has no impact on its employment. On the other hand, higher export intensity of an industry increases employment in the industry but has no effect on its wage rate. Technological progress is found to be labor saving but does not influence the wage rate. Further, the results show that domestic innovation in terms of research and development intensity has been labor utilizing in nature but import of technology has unfavorably affected employment in India. Rajit Kumar Sahoo(2005) has pointed out that FDI has a direct and indirect impact and on a certain particular sectors of the economy. A study on the impact of FDI on manufacturing sector reveals that FDI inflows in chemicals, electrical and electronics shows direct impact and FDI inflow in drugs and pharmaceutical sectors shows indirect impact (spillover effects). FDI is an important vehicle for the transfer of technology and knowledge and it demonstrates that it can have a long run effect on growth by

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generating increasing return in production via positive externalities and productive spillovers. Thus, FDI can lead to a higher growth by incorporating new inputs and techniques (Feenstra and Markusen, 1994). Jaya Gupta (2007) made an attempt to review the change in sectoral trends in India due to FDI Inflows since liberalization. This paper also examines the changed policy implications on sectoral growth and economic development of India as a whole. Jayashree Bose (2007) in his book studied the sectoral experiences faced by India and China in connection with FDI inflows. This book provides information on FDI in India and China, emerging issues, globalization, foreign factors, trends and issues in FDI inflows, FDI inflows in selected sectors. A comparative study has also been conducted on FDI outflows from India and China. This book also revealed the potential and opportunities in various sectors in India that would surpass FDI inflows in India as compared to China. Several studies have focused on theoretical positive impact of FDI on growth. But there are only few empirical studies of this facet. Both macro and micro studies have generally been conducted to study the relationship between FDI and growth. Micro studies find no positive evidence to support the thesis that FDI positively contributes to growth. Macro studies, have, however, thrown up some evidence to show that FDI positively affects economic growth under certain conditions. Although there are many literatures between FDI and growth, there are also ambiguous in this issue. UNCTAD (2002) found that FDI might have positive effect on output for some countries and negative for others, because of different dependent variables. Compare to the major literatures of endogenous growth model, it seems that the studies of the impact of FDI on growth are still too narrow, since there are some undecided factors. First, there are not enough determined proofs to show that FDI has direct real benefits on growth (or output level), except spillover effect. Second, FDI is a new phenomenon in social, economics and global politics, but the empirical studies in the long-term relationship between FDI and output are still very few. A number of studies have analyzed the relationship between FDI inflows and economic growth, the issue is far from settled in view of the mixed findings reached. Most of these studies have typically adopted standard growth accounting framework for analyzing the effect of FDI inflows on growth of national income along with other factors of production. Existing studies do not fully control for simultaneity bias, country-specific effects, and the routine use of lagged dependent variables in growth regressions. These weaknesses can bias the coefficient estimates as well as the coefficient standard errors. Thus, the profession needs to reassess the macroeconomic evidence with econometric procedures that eliminate these potential biases. Although there are literatures using VAR or VECM analysis to do Granger causality test, but most of them were lacking economic theory or ignored important disturbance variables. Our study will strive to highlight the

nexus between FDI and economic growth in India under co integration framework. 4. Methodology: 4.1. Data and Variables The objective of this paper is to explore the causal nexus between FDI (Foreign Direct Investment) economic growth in India using the annual data for the period, 1990-91 to 2010-11 which includes the 21 annual observations. The two main variables of this study are economic growth and FDI. The real Gross Domestic Product (GDP) is used as the proxy for economic growth in India and we represent the economic growth rate by using the constant value of Gross Domestic Product (GDP) measured in Indian rupee. All necessary data for the sample period are obtained from the Handbook of Statistics on Indian Economy, 2010-11 published by Reserve Bank of India. All the variables are taken in their natural logarithms to reduce the problems of heteroscedasticity to maximum possible extent. Using the time period, 1990-91 to 2010-11 for India, this study aims to examine the long-term and causal dynamic relationships between the level of FDI flowing into India and economic growth. The estimation methodology employed in this study is the cointegration and error correction modeling technique. The entire estimation procedure consists of three steps: first, unit root test; second, cointegration test; third, the error correction model estimation. 4.2. Econometric specification: 4.2.1 Hypothesis: The paper is based on the following hypotheses for testing the causality and co-integration between GDP and FDI in India (i) whether there is bi-directional causality between GDP growth and FDI, (ii) whether there is unidirectional causality between the two variables, (iii) whether there is no causality between GDP and FDI in India (iv) whether there exists a long run relationship between GDP and FDI in India. 4.2.2.Model Specification The choice of the existing model is based on the fact that it allows for generation and estimation of all the parameters without resulting into unnecessary data mining. The growth model for the study takes the form: GDP=f (FDI) -------------------(1) Where GDP and FDI are the gross domestic product and foreign direct investment respectively. Equation (1) is treated as a Cobb-Douglas function with foreign direct investment into India, (FDI), as the only explanatory variable.

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The link between Economic growth (measured in terms of GDP growth) and foreign direct investment in India can be described using the following model in linear form: LnGDPt= + Ln FDI t + t -------------- (1.1) and >0 The variables remain as previously defined with the exception of being in their natural log form. t is the error term assumed to be normally, identically and independently distributed. Here, GDP t and FDI t show the Gross Domestic Product annual growth rate and foreign direct investment growth at a particular time respectively while t represents the noise or error term; and represent the slope and coefficient of regression. The coefficient of regression, indicates how a unit change in the independent variable (foreign direct investment) affects the dependent variable (gross domestic product). The error, t, is incorporated in the equation to cater for other factors that may influence GDP. The validity or strength of the Ordinary Least Squares method depends on the accuracy of assumptions. In this study, the Gauss-Markov assumptions are used and they include; that the dependent and independent variables (GDP and FDI) are linearly co-related, the estimators (, ) are unbiased with an expected value of zero i.e., E (t) = 0, which implies that on average the errors cancel out each other. The procedure involves specifying the dependent and independent variables; in this case, GDP is the dependent variable while FDI the independent variable. But it depends on the assumptions that the results of the methods can be adversely affected by outliers. In addition, whereas the Ordinary Least squares regression analysis can establish the dependence of either GDP on FDI or vice versa; this does not necessarily imply direction of causation. Stuart Kendal noted that a statistical relationship, however, strong and however suggestive, can never establish causal connection. Thus, in this study, another method, the Granger causality test, is used to further test for the direction of causality. Step I: Ordinary least square method: Here we will assume the hypothesis that there is no relationship between foreign direct investment (FDI) and Economic Growth in terms of GDP. To confirm about our hypothesis, primarily, we have studied the effect of foreign direct investment inflow on economic growth and vice versa by two simple regression equations: FDIi=a+ b*GDPi ..(2) GDPi=a1+ b1*FDIi..(3) GDP = Gross domestic product. FDI = Foreign Direct Investment into India. t= time subscript.

This study aimed to examine the long-term relationship between foreign direct investment and GDP growth in India between 1990-91 and 2010-11. Using co-integration and Vector Error Correction Model (VECM) procedures, we investigated the relationship between these two variables. The likely short-term properties of the relationship among economic growth and foreign direct investment were obtained from the VECM application. Next, unit root, VAR, cointegration and Vector Error Correction Model (VECM) procedures were utilized in turn. The first step for an appropriate analysis is to determine if the data series are stationary or not. Time series data generally tend to be nonstationary, and thus they suffer from unit roots. Due to the non-stationarity, regressions with time series data are very likely to result in spurious results. The problems stemming from spurious regression have been described by Granger and Newbold (1974). In order to ensure the condition of stationarity, a series ought to be integrated to the order of 0 [I(0)]. In this study, tests of stationarity, commonly known as unit root tests, were adopted from Dickey and Fuller (1979, 1981) and Phillips-Perron test. As the data were analyzed, we discovered that error terms had been correlated in the time series data used in this study. Step II: The Stationarity Test (Unit Root Test) When dealing with time series data, a number of econometric issues can influence the estimation of parameters using OLS. Regressing a time series variable on another time series variable using the Ordinary Least Squares (OLS) estimation can obtain a very high R2, although there is no meaningful relationship between the variables. This situation reflects the problem of spurious regression between totally unrelated variables generated by a non-stationary process. Therefore, prior to testing Cointegration and implementing the Granger Causality test, econometric methodology needs to examine the stationarity; for each individual time series, most macro economic data are non stationary, i.e. they tend to exhibit a deterministic and/or stochastic trend. Therefore, it is recommended that a stationarity (unit root) test be carried out to test for the order of integration. A series is said to be stationary if the mean and variance are time-invariant. A non-stationary time series will have a time dependent mean or make sure that the variables are stationary, because if they are not, the standard assumptions for asymptotic analysis in the Granger test will not be valid. Therefore, a stochastic process that is said to be stationary simply implies that the mean [(E(Yt)] and the variance [Var (Yt)] of Y remain constant over time for all t, and the covariance [covar (Yt, Ys)] and hence the correlation between any two values of Y taken from different time periods depends on the difference apart in time between the two values for all ts. Since standard regression analysis requires that data series be stationary, it is obviously important that we first test for this requirement to determine whether the series used in the regression process is a difference stationary or a trend stationary. The Augmented Dickey-Fuller (ADF) test

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is used. To test the stationary of variables, we use the Augmented Dickey Fuller (ADF) test which is mostly used to test for unit root. Following equation checks the stationarity of time series data used in the study: y
t=

+ t+y
1 1

t-1

t-1 + t

-----(4)

Where is white nose error term in the model of unit root

t

test, with a null hypothesis that variable has unit root. The ADF regression test for the existence of unit root of yt that represents all variables (in the natural logarithmic form) at time t. The test for a unit root is conducted on the coefficient of yt-1 in the regression. If the coefficient is significantly different from zero (less than zero) then the hypothesis that y contains a unit root is rejected. The null and alternative hypothesis for the existence of unit root in variable yt is H0; = 0 versus H1: < 0. Rejection of the null hypothesis denotes stationarity in the series. If the ADF test-statistic (t-statistic) is less (in the absolute value) than the Mackinnon critical t-values, the null hypothesis of a unit root can not be rejected for the time series and hence, one can conclude that the series is nonstationary at their levels. The unit root test tests for the existence of a unit root in two cases: with intercept only and with intercept and trend to take into the account the impact of the trend on the series. The PP tests are non-parametric unit root tests that are modified so that serial correlation does not affect their asymptotic distribution. PP tests reveal that all variables are integrated of order one with and without linear trends, and with or without intercept terms. PhillipsPerron test (named after Peter C. B. Phillips and Pierre Perron) is a unit root test. That is, it is used in time series analysis to test the null hypothesis that a time series is integrated of order 1. It builds on the DickeyFuller test , of the null hypothesis = 0 in here is the first difference operator. Like the augmented DickeyFuller test, the PhillipsPerron test addresses the issue that the process generating data for yt might have a higher order of autocorrelation than is admitted in the test equation - making yt 1 endogenous and thus invalidating the DickeyFuller t-test. Whilst the augmented Dickey Fuller test addresses this issue by introducing lags of yt as regressors in the test equation, the PhillipsPerron test makes a non-parametric correction to the t-test statistic. The test is robust with respect to unspecified autocorrelation and heteroscedasticity in the disturbance process of the test equation. Once the number of unit roots in the series was decided, the next step before applying Johansens (1988) cointegration test was to determine an appropriate number of lags to be used in estimation. Second, Eagle-Granger residual based test tests the existence of co integration among the variables-FDI and GDP at constant prices for the economy. Third, if a co integration relationship does not exist, VAR analysis in the first difference is applied,

however, if the variables are co integrated, the analysis continues in a cointegration framework. Several tests of non-stationarity called unit root tests have been developed in the time series econometrics literature. In most of these tests the null hypothesis is that there is a unit root, and it is rejected only when there is strong evidence against it. Most tests of the Dickey-Fuller (DF) type have low power (see Dejong et al. 1992). Because of this Maddala and Kim (1998) argue that DF, ADF (augmented Dickey-Fuller) and PP (Phillips and Perron) tests should be discarded. We, therefore, use the KPSS (Kwiatkowski, Phillips, Schmidt and Shin 1992) test which is considered relatively more powerful (BahmaniOskooee et.al.,1999). The KPSS Lagrange Multiplier tests the null of stationarity (H0: < 1) against the alternative of a unit root (H1: =1). In econometrics, KwiatkowskiPhillipsSchmidtShin (KPSS) tests are used for testing a null hypothesis that an observable time series is stationary around a deterministic trend. The series is expressed as the sum of deterministic trend, random walk, and stationary error, and the test is the Lagrange multiplier test of the hypothesis that the random walk has zero variance. KPSS type tests are intended to complement unit root tests, such as the DickeyFuller tests. By testing both the unit root hypothesis and the stationarity hypothesis, one can distinguish series that appear to be stationary, series that appear to have a unit root, and series for which the data (or the tests) are not sufficiently informative to be sure whether they are stationary or integrated. The KPPS (1992) Test is based on the residuals( ) from an
t

ordinary least square regression of the variable of interest on the exogenous variable(s) as follows: Yt = Xt +
t (5)

where Yt is the variable of interest (real exchange rate) and Xt is a vector of exogenous variable(s). The Lagrange Multiplier (LM) statistic used in the test as follows:
T

LM = T 2 S (t )2 / f0 (6)
i =1

where T is the sample size, S(t) is the partial sum of

t

residuals which is calculated as

t

S (t ) = S r .
i =1

Here is the estimated residual from (3.1).

f0 is an

estimator of the residual spectrum at frequency zero. This statistic has to be compared with KPSS et al. (1992) critical values. Step-III: Testing Approach) for Cointegration Test(Johansen

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Cointegration, an econometric property of time series variable, is a precondition for the existence of a long run or equilibrium economic relationship between two or more variables having unit roots (i.e. Integrated of order one). The Johansen approach can determine the number of cointegrated vectors for any given number of non-stationary variables of the same order. Two or more random variables are said to be cointegrated if each of the series are themselves non stationary. This test may be regarded as a long run equilibrium relationship among the variables. The purpose of the Cointegration tests is to determine whether a group of non stationary series is cointegrated or not. Having concluded from the ADF results that each time series is non-stationary, i.e it is integrated of order one I(1), we proceed to the second step, which requires that the two time series be co-integrated. In other words, we have to examine whether or not there exists a long run relationship between variables (stable and non-spurious co-integrated relationship). In our case, the mission is to determine whether or not foreign direct investment (FDI) and economic growth (GDP) variables have a long-run relationship in a bivariate framework. Engle and Granger (1987) introduced the concept of cointegration, where economic variables might reach a long-run equilibrium that reflects a stable relationship among them. For the variables to be co-integrated, they must be integrated of order one (non-stationary) and the linear combination of them is stationary I(0). The crucial approach which is used in this study to test r cointegration is called the Johansen cointegration approach. The Johanson approach can determine the number of cointegrated vectors for any given number of nonstationary variables of the same order. Step-IV: The Granger Causality test : Causality is a kind of statistical feedback concept which is widely used in the building of forecasting models. Historically, Granger (1969) and Sim (1972) were the ones who formalized the application of causality in economics. Granger causality test is a technique for determining whether one time series is significant in forecasting another (Granger. 1969). The standard Granger causality test (Granger, 1988) seeks to determine whether past values of a variable helps to predict changes in another variable. The definition states that in the conditional distribution, lagged values of Yt add no information to explanation of movements of Xt beyond that provided by lagged values of Xt itself (Green, 2003). We should take note of the fact that the Granger causality technique measures the information given by one variable in explaining the latest value of another variable. In addition, it also says that variable Y is Granger caused by variable X if variable X assists in predicting the value of variable Y. If this is the case, it means that the lagged values of variable X are statistically significant in explaining variable Y. The null hypothesis (H0) that we test in this case is that the X variable does not Granger cause variable Y and variable Y does not Granger

cause variable X. In summary, one variable (Xt) is said to granger cause another variable (Yt) if the lagged values of Xt can predict Yt and vice-versa. FDI and GDP are, in fact, interlinked and co-related through various channel. There is no theoretical or empirical evidence that could conclusively indicate sequencing from either direction. For this reason, the Granger Causality test was carried out on FDI and GDP. The spirit of Engle and Granger (1987) lies in the idea that if the two variables are integrated as order one, I(1), and both residuals are I(0), this indicates that the two variables are cointegrated. The Granger theorem states that if this is the case, the two variables could be generated by a dynamic relationship from GDP to FDI and, vise versa. Therefore, a time series X is said to Granger-cause Y if it can be shown through a series of F-tests on lagged values of X (and with lagged values of Y also known) that those X values predict statistically significant information about future values of Y. In the context of this analysis, the Granger method involves the estimation of the following equations: If causality (or causation) runs from FDI to GDP, we have: dLnGDPit = i+ 11dLnGDPi, t-1+ 11dLnFDIi, (7)
t-1

+1t

If causality (or causation) runs from GDP to FDI, it takes the form: dLnFDIit = i+12dLn FDIi,t-1 +12dLnGDPi,t-1 +ECMit+2t.(8) Where GDPt and FDIt represent gross domestic product and foreign direct investment respectively, it is uncorrelated stationary random process, and subscript t denotes the time period. In equation 4, failing to reject: H0: 11 = 11 =0 implies that foreign direct investment does not Granger cause economic growth. On the other hand, in equation5, failing to reject H0: 12= 12 =0 implies that economic growth via GDP growth does not Granger cause foreign direct investment. The decision rule: From equation (7), dLnFDIi, t-1Granger causes dLnGDPi t if the coefficient of the lagged values of FDI as a group (11) is significantly different from zero based on F-test (i.e., statistically significant). Similarly, from equation (8), dLnGDPi,t-1 Granger causes dLnFDIit if 12is statistically significant. Step V: Error Correcting Model (ECM) and Short Term Causality Test : Error correction mechanism was first used by Sargan (1984), later adopted, modified and popularized by Engle and Granger (1987). By definition, error correction mechanism is a means of reconciling the short-run behaviour (or value) of an economic variable with its longrun behaviour (or value). An important theorem in this

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regard is the Granger Representation Theorem which demonstrates that any set of cointegrated time series has an error correction representation, which reflects the short-run adjustment mechanism. Co- integration relationships just reflect the long term balanced relations between relevant variables. In order to cover the shortage, correcting mechanism of short term deviation from long term balance could be cited. At the same time, as the limited number of years, the above test result may cause disputes (Christpoulos and Tsionas, 2004). Therefore, under the circumstance of long term causalities, short term causalities should be further tested as well. Empirical works based on time series data assume that the underlying time series is stationary. However, many studies have shown that majority of time series variables are nonstationary or integrated of order 1 (Engle and Granger, 1987). The time series properties of the data at hand are therefore studied in the outset. Formal tests will be carried out to find the time series properties of the variables. If the variables are I (1), Engle and Granger (1987) assert that causality must exist in, at least, one direction. The Granger causality test is then augmented with an error correction term (ECT) and the error correcting models could be built as below:
Variable

dLnGDPit = i+ 11dLnGDPi,t-1+ ECMit+it.(9)

11dLnFDIi,t-1+

dLnFDIit = i+12dLn FDIi,t-1 +12dLnGDPi,t-1 +ECMi t+it.(10) Where t represents year, d rerepresents first order difference calculation, ECMit represents the errors of long term balance which is obtained from the long run cointegrating relationship between economic growth and foreign direct investment. If = 0 is rejected, error correcting mechanism happens, and the tested long term causality is reliable, otherwise, it could be unreliable. If 1=0 is rejected, and then the short term causality is proved, otherwise the short term causality doesnt exist. 5. ANALYSIS OF RESULT: 5.1. Ordinary Least Square Technique: This section presents the nexus between foreign direct investment and economic growth in terms of OLS Technique.

Table: 3:Result of OLS Technique Dependent variable is LnGDP Coefficient SE t ratio Ln FDI 1.476509 0.056322 26.21527 Dependent variable is Ln FDI LnGDP 0.658121 0.025104 26.21527 Ho: There is no relationship between the variables; H1: There is relationship between the variables Source: Authors own estimate

R2 0.321 0.274

In ordinary least square Method, we reject the null hypothesis that there is no relationship between the variable and the results of the Ordinary Least Squares Regression are summarized in the Table 3. The empirical analysis on basis of ordinary Least Square Method suggests that there is positive relationship between foreign direct investment(FDI)investment and GDP and vice versa. 5.2. Unit Root Test: Table 4&5 present the results of the unit root test. The results show that both variables of our interest, namely LnGDP and Ln FDI did not attain stationarity after first

differencing, I(1), using both ADF and PP test. The augmented Dickey Fuller Test and Phillips-Perron (P-P) Test fail to provide result of stationary at first difference at all lag differences. Table (4) and (5) present the results of the unit root test for the two variables for their levels and first differences. The results indicate that the null hypothesis of a unit root can not be rejected for the given variable as none of the ADF value and PP value is not smaller than the critical t-value at 1% ,5% and 10%level of significance for all variables and, hence, one can conclude that the variables are not stationary at their levels and first differences both in ADF and PP test.

Table 4: Unit Root Test: The Results of the Augmented Dickey Fuller (ADF) Test for Level &First differences with an Intercept and Linear Trend Variable Intercept only Intercept&Trend LnGDP ADF(0) ADF(1) ADF(2) ADF(0) ADF(1) ADF(2) Level 1.076 0.856 0.621 -1.668 -1.436 -1.508 AIC -2.547 -2.413 -2.232 -2.649 -2.477 -2.321 SBC -2.447 -2.264 -2.034 -2.500 -2.279 -2.074 First differences -4.229 -2.591 -1.947 -4.435 -2.746 -2.07 AIC -2.473 -2.316 -2.131 -2.454 -2.271 -2.073 SBC -2.374 -2.168 -1.935 -2.305 -2.073 -1.828 Ln FDI

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-3.048 -2.441 -1.623 0.762 0.770 0.820 0.862 0.919 1.018 -2.283 -2.719 -2.146 0.982 0.882 1.070 1.081 1.030 1.266 1% Critical Value* -3.83 5% Critical Value -3.02 10% Critical Value -2.66 Ho: series has unit root; H1: series is trend stationary *MacKinnon critical values for rejection of hypothesis of a unit root. AIC stands for Akaike info criterion SBC stands for Schwarz Bayesian criterion Source: Authors own estimate

Level AIC SBC First differences AIC SBC

-2.371 -3.550 0.743 0.465 0.892 0.664 -2.711 -2.882 0.970 0.925 1.119 1.123 1% Critical Value* -4.57 5% Critical Value -3.69 10% Critical Value -3.27

-2.495 0.645 0.892 -2.401 1.098 1.343

Table 5: Unit Root Test: The Results of the Phillips-Perron (PP) Test for Level &First differences with an Intercept and Linear Trend Variable Intercept only Intercept&Trend LnGDP PP(0) PP(1) PP(2) PP(0) PP(1) PP(2) Level 1.076 1.157 1.176 -1.668 -1.67 -1.69 AIC -2.547 -2.547 -2.547 -2.649 -2.649 -2.649 SBC -2.447 -2.447 -2.447 -2.500 -2.501 -2.500 First differences -4.229 -4.229 -4.230 -4.435 -4.435 -4.435 AIC -2.473 -2.473 -2.473 -2.454 -2.454 -2.454 SBC -2.374 -2.374 -2.374 -2.305 -2.305 -2.305 Ln FDI -3.048 -2.79 -2.782 0.762 0.7629 0.7629 0.862 0.8625 0.8625 -2.283 -2.30 -2.22 0.982 0.982 0.982 1.081 1.081 1.081 1% Critical Value* -3.83 5% Critical Value -3.02 10% Critical Value -2.66 Ho: series has unit root; H1: series is trend stationary *MacKinnon critical values for rejection of hypothesis of a unit root. AIC stands for Akaike info criterion SBC stands for Schwarz Bayesian criterion Source: Authors own estimate Level AIC SBC First differences AIC SBC -2.371 -2.376 0.7434 0.7434 0.8928 0.8928 -2.71 -2.779 0.9705 0.9705 1.119 1.119 1% Critical Value* -4.57 5% Critical Value -3.69 10% Critical Value -3.27 -2.373 0.7434 0.8928 -2.734 0.9705 1.1196

An inspection of the figures reveals in table-6 that each series is first difference stationary at 1%,5% and 10% level using the KPSS test. However, the ADF and PP test result are not as impressive, as all the variables did not pass the differenced stationarity test at the one, five and ten percent

levels. We therefore rely on the KPSS test result as a basis for a cointegration test among all stationary series of the same order meaning that the two series are stationary at their first differences [they are integrated of the order one i.e I(1)].

Table:6: Kwiatkowski, Phillips, Schmidt and Shinn(KPSS) test Ln GDP-Gross Domestic Product Countries KPSS level KPSS First Difference Without Trend With trend Without Trend India KPSS(0) 2.033 0.393542 0.2874 KPSS(1) 1.093 0.229995 0.2877 KPSS(2) 0.7758 0.173944 0.2704

With trend 0.0557706 0.0621724 0.064436

LnFDI-Foreign Direct Investment Countries KPSS level Without Trend India KPSS(0) 1.8519 KPSS(1) 1.0247 KPSS(2) 0.7490

With trend 0.2535 0.1550 0.1283

KPSS First Differences Without Trend 0.4830 0.3396 0.3084

With trend 0.13216 0.0990 0.0949

In contrast, the null hypothesis under the KPSS test states that there exist a stationary series. Ho: series is trend stationary ; H1: series is non stationary Note: 1) 1%, 5% and 10% critical values for KPSS are 0.739, 0.463 and 0.347 for without trend.

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2)1%, 5% and 10% critical values for KPSS with trend are 0.216, 0.146 and 0.1199. 3) *, **, *** denotes acceptance of the null hypothesis of trend stationarity at the 1%, 5%, and 10% significance levels, respectively. 4) The null hypothesis of stationarity is accepted if the value of the KPSS test statistics is less than it is critical value. 5) the null of level stationarity is tested. Source: Authors own estimate

5.3. Cointegration Test Having established the time series properties of the data, the test for presence of long-run relationship between the variables using the Johansen and Juselius (1992) LR statistic for cointegration was conducted. The crucial approach which is used in this study to test cointegration is called the Johansen cointegration approach. The Johanson
Hypothesized N0. Of CE (s) None ** Eigen value

approach can determine the number of cointegrated vectors for any given number of non-stationary variables of the same order. The results reported in table (7) suggest that the null hypothesis of no cointegrating vectors can be rejected at the 1% level of significance. It can be seen from the Likelihood Ratio (L.R.) that we have two co-integration equations. In other words, there exists two linear combination of the variables.
1% critical value 16.31 6.51

Table 7. Johansen Cointegration Tests: Likelihood Ratio 5% critical value 34.81754 12.53 3.84

0.718362

At most 1 ** 0.377334 9.474899 Ho: has no co-integration; H1: has co-integration Source: Authors own estimate *(**) denotes rejection of the hypothesis at 5%(1%) significance level L.R. test indicates two cointegrating equation(s) at 5% significance level

The normalized cointegrating equation is LnGDP = -9.825+ 0.931112 LnFDI ------------------(11) (0.20639) The standard error is in the parentheses the behavioural parameter (FDI) is statistically significant at 1%. Estimating the long-run relationship, the results are contained in equation (11) which shows positive relationship between foreign direct investment and economic growth. Precisely, 1% increase in FDI raises the level of GDP by 0.93%.Therefore,the normalized cointegration equation reveals that there is a positive relationship between foreign direct investment (FDI) and GDP(Economic growth).Looking at the results, the normalized cointegrating equation (11) reveals that in the
Null Hypothesis LnFDI does not Granger Cause LnGDP LnGDP does not Granger Cause LnFDI

long-run, FDI affects economic growth positively in India. Interestingly, this result is impressive because 1% change in FDI volume leads to about 0.93 percent change in economic growth via GDP growth in the same direction, over the long-run horizon. This of course is highly significant judging from the t-statistic. 5.4. Granger Causality Test: The results of Pairwise Granger Causality between economic growth (GDP) and foreign direct investment (FDI) are contained in Table 8. The results reveal the existence of a bi-directional causality which runs from economic growth (GDP) to investment in foreign direct investment (FDI) and vice versa

Table: 8: Granger Causality test Lag Observations. F-statistics 2 19* 0.10980

Probability 0.89678

Decision Accept

19

10.6012

0.00157

Reject

*Observations. after lag. Source: Authors own estimate

We have found that for the Ho of LNFDI does not Granger Cause LNGDP, we cannot reject the Ho since the F-statistics are rather small and most of the probability values are close to or even greater than 0.1 at the lag length of 2. Therefore, we accept the Ho and conclude that LNFDI does not Granger Cause LNGDP, but for Ho of LNGDP does not Granger Cause LNFDI ,we reject Ho and conclude that LNGDP does Granger Cause LNFDI.This means that economic growth accelerates and augments

foreign direct investment inflow into India and therefore we find that the direction of causality between foreign direct investment indicators and economic growth in India is generally unidirectional (causality runs from economic growth to foreign direct investment). 5.5. Error Correction Mechanism(VECM):

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The coefficients of Error Correction Term contain information about whether the past values affect the current values of the variable under study. A significant coefficient implies that past equilibrium errors play a role in determining the current outcomes. The information obtained from the ECM is related to the speed of adjustment of the system towards long-run equilibrium. The short-run dynamics are captured through the individual coefficients of the difference terms. The adjustment coefficient on ECT in equation (9) is negative and statistically significant at 1% level of significance

indicating that, when deviating from the long-term equilibrium, error correction term has an opposite adjustment effect and the deviation degree is reduced. The significant error term also supports the existence of longterm relationship between FDI flow and economic growth. The Error-Correction Term is statistically significant and has a negative sign, which confirms that there isnt any problem in the long-run equilibrium relation between the independent and dependent variables. Their relative price 0.3773 (-3.43460) denotes a satisfactory convergence rate to equilibrium point per period.

Table:9: Short term causality test for time series data(VECM) Variables Model-1 Model-2 D(LNFDI) D(LNGDP) ECM -0.377312* -0.006133 (0.10986) (0.03725) (-3.43460) (-0.16464) D(LNFDI(-1)) 0.148231 -0.025675 (0.20403) (0.06919) (0.72650) (-0.37108) D(LNFDI(-2)) -0.068333 -0.031222 (0.16145) (0.05475) (-0.42325) (-0.57026) D(LNGDP(-1) 2.540856 -0.062398 (0.82711) (0.28048) (3.07196) (-0.22247) D(LNGDP(-2)) 1.280484 0.156389 (1.08477) (0.36786) (1.18042) (0.42513) R-squared 0.7463 0.07901 F-statistic 7.061745 0.205893 *indicates panel data pass the significance test by 95% level. Source: Authors own estimate

6. CONCLUSION: The paper tries to assess empirically, the relationship between foreign direct investment (FDI) and economic growth in India using annual data over the period 1990-91 to 2010-11. The unit root properties of the data were examined using the Augmented Dickey Fuller test(ADF), Phillips-Perron (PP) Test , Kwiatkowski, Phillips, Schmidt and Shinn(KPSS) test after which the cointegration and causality tests were conducted. The error correction models were also estimated in order to examine the short-run dynamics. The major findings include the following: In ordinary least square Method, we reject the null hypothesis that there is no relationship between the variables and the empirical analysis on basis of ordinary Least Square Method suggests that there is positive relationship between foreign direct investment(FDI)investment and GDP and vice versa. In addition, whereas the Ordinary Least squares regression analysis can establish the dependence of either GDP on FDI or vice versa; this does not necessarily imply direction of causation. The unit root test clarified that both economic growth and foreign direct investment are non-stationary at both level and the first differences in case of Augmented Dickey Fuller test(ADF), Phillips-Perron (PP) Test. But, the series of both variables of our consideration-FDI and GDP, namely, foreign direct investment and economic growth

were found to be integrated of order one using the Kwiatkowski, Phillips, Schmidt and Shinn(KPSS) test for unit root. The cointegration test confirmed that economic growth and foreign direct investment are cointegrated, indicating an existence of long run equilibrium relationship between the two as confirmed by the Johansen cointegration test results. The Granger causality test finally confirmed the presence of uni-directional causality which runs from economic growth to foreign direct investment The error correction estimates gave evidence that the Error-Correction Term is statistically significant and has a negative sign, which confirms that there isnt any problem in the long-run equilibrium relation between the independent and dependent variables. Their relative price 0.3773 (-3.43460) denotes a satisfactory convergence rate to equilibrium point per period. The result shows that FDI has not contributed much to the economic growth in India for the time period 1990-912010-11, therefore it is imperative for the government of India to make a policy for attracting FDI in such a way that it should be more growth enhancing than growth retarding. Moreover, despite the tremendous potential of FDI in economic development, it does not provide answers to all developmental problems. Public policies need to be in place to support the poorer segments of society. The role of FDI in this process is, by virtue of its impact on productivity and

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growth, to generate the resources needed to fund the government-led programs that improve social safety nets and provide basic social services. Moreover, the delivery of social services to the poor from insurance schemes to access to basic services such as water and energy can also benefit from reliance on foreign investors. It is thus imperative for the national governments to create the preconditions for FDI to flow in and work its wonders. A liberal and competitive investment climate creates the basis for FDI to enter and raise the potential for productivity growth in the host economy, but improvements will only occur if the domestic actors are capable of responding to the new incentives. The key policy measures are thus to improve the education and infrastructure so as to increase the domestic absorptive capacity of the fruits of FDI. For FDI to be a noteworthy provider to economic growth, India would do better by focusing on improving infrastructure, human resources, developing local entrepreneurship, creating a stable macroeconomic framework and conditions favourable for productive investments to augment the process of development. References:
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