Foreign Direct Investment and Foreign Trade in India: What Causes What?

Abstract

Hsiao's sequential approach based on the concept of Granger causality and Akaike's Final Prediction Error criterion was employed to examine the short-run causal nexus between foreign direct investment (FDI) and foreign trade (imports and exports) in India. The data base were on monthly basis and it covered from July 1992 to October 2003. By and large, the analysis reveals:

(i) an independent relationship between FDI and imports due to the fact that time period after liberalisation of FDI is not sufficient enough and the size of the FDI is also very meager in India compared to other developing countries.

(ii) there is a unidirectional causality from export to FDI and it may be due to the outward oriented export led development policy which will attract FDI inflow in India in the short-run, and

(iii) Aggregate imports and exports are bi-directional in India in the short-run during the period of our study. This is because, India has to export and earn sufficient foreign exchange reserves in order to finance to import from trading partners.

Keywords: Foreign Direct Investment, Foreign Trade, Granger Causality

JEL Classification: F14, F21, F23