Indian Economic Reforms and Foreign Direct Investment

Abstract

The unprecedented emergence of a country as large as India in the South Asian region raises the issue of how it will affect neighbouring economies in terms of attracting FDI inflows. Do huge FDI inflows of India lead to ‘ investment creating effect’ or otherwise for its neighbours? If so, is this positive impact conditioned by local economic reforms in India? These are the issues we try to explore empirically using data for four South Asian economies (Pakistan, Sri Lanka, Bangladesh and Nepal) from 1975 to 2006 and control for other key determinants of FDI inflows. Using the Chantasasawat et al. (2004) and Mercereau (2005) approach, we make use of five different alternative measures to create ‘ India effect’ and examine its impact on FDI inflows of its neighbours. Using all the five measures, the results suggest that the India effect is positively related to the levels of FDI inflows of its neighbours. There is an evidence to support that the positive impact of Indian FDI inflows on its neighbours is conditioned by Indian economic reforms. Also found is the negative effect of reversal of Indian reforms on neighbours’ FDI inflows.