Determinants of Foreign Direct Investment in India

The main aim of this thesis is to analyze the determinants of foreign direct investment in India by using GDP, Inflation, Economy Openness and Real Effective Exchange rate as determining variables. This study uses time series data from 1978 to 2014. The unit root test revealed that the variables were stationary at first level I(1). The variables were found to be co-integrated after conducting the Johanson’s Co-integration text. In order to determine the long run coefficients of the variables, we used the Vector Error Correction Model (VECM) that produced the following results. GDP was found to be positive and statistically significant variable exhibiting a positive relationship between FDI and GDP. The VECM reveals exchange rate as a significant determinant of FDI in India. This indicates that the strength of India’s currency is a measure factor in attracting FDI to India. The results of this study also provide evidence that inflation is negatively related to FDI in the long run probably because of the instability it causes in the economy. Trade openness is negative and statistically significant indicating a negative relationship with FDI probably because investors coming in are market seeking oriented and not export oriented. Also, trade openness may increase the number of competitors in the domestic market. Keywords: Foreign Direct Investment, Unit root test, Johanson Co-integration, VECM and India.