This research delves into the complex relationship between foreign direct investment (FDI) inflows and domestic investment in India, data spanning from 1st Quarter (Q1) of 1997 to 4th Quarter (Q4) of 2019. In other words, the aim of this paper is to examine whether FDI has a crowding-in or crowding-out effect on domestic investment in India using a multivariate model wherein economic growth, trade openness, and financial development are included as additional variables.
Employing estimation techniques with a focus on structural breaks, we utilize both the Gregory–Hansen cointegration test and the autoregressive distributed lag (ARDL) bounds testing approach to cointegration. Additionally, the stationarity properties of the variables are assessed employing the Zivot-Andrews unit root test.
This study confirms the existence of a long-run relationship between FDI inflows and domestic investment in India. Notably, the results indicate a significant crowding-out effect of FDI on domestic investment. The results suggest that increased foreign investment may potentially displace or hinder domestic investment initiatives. Further, the study reveals that factors such as economic growth, financial development and trade openness have a positive and stimulating impact on domestic investment in both the long run and short run.
Based on these findings, we conclude that because of the significant crowding-out impact of FDI on domestic investment, policymakers need to be cautious while formulating their sustainable growth-stimulating policy for India, focusing on FDI. They should not simply believe that inflows of FDI always help increase the ability to produce in the economy; quality FDI should especially be encouraged. It also highlights that a significant positive effect of economic growth, financial development, and trade openness on domestic investment indicates the importance of fostering an environment conducive to domestic investment, taking into account various economic growth drivers.
