The Effect of Liberalization of Foreign Direct Investment (FDI) Limits on Domestic Stocks: Evidence from the Indian Banking Sector

Abstract

Foreign Direct investment (FDI) limits were liberalized in India to allow greater than fifty-one percent ownership of private sector banks in February, 2002. Portfolios of private sector and government owned banks posted significant and large value gains surrounding the announcement, the gains by private sector banks being almost double that by government banks. The analysis shows that the price increase is higher for smaller banks that have less debt, are less efficient, less productive, and burdened with non-performing assets. We conclude the evidence is consistent with the hypothesis that the valuation gains reflect the vulnerability to and premium of potential takeover of the inefficient banks following the liberalization.

Keywords: Banking, FDI, Foreign Direct Investment, stock prices, event study, performance