Inward FDI & Development
Opening the Gates: India’s FDI Journey
The Big Question What drives foreign companies to invest in India – or holds them back? This pioneering study examines how India’s dramatic economic reforms in 1991 reshaped foreign investment patterns and what factors really matter in attracting global capital.
The Journey: Three Phases of India’s FDI Story
Phase 1: The Cautious Years (1955-1979)
- Tight restrictions on foreign ownership
- Limited FDI growth – just Rs. 489 crores over 24 years
- Focus on protecting domestic industry
- Growth rate: Only 3.5% per year
Phase 2: Testing the Waters (1980-1990)
- Partial liberalization begins
- FDI stock grows to Rs. 2,705 crores
- Manufacturing remains dominant sector
- Growth rate accelerates to 12% per year
Phase 3: The Open Door (1991-1999)
- Radical policy reforms launched
- FDI stock explodes to Rs. 50,306 crores
- Services sector emerges as major destination
- Growth surges to 49% per year
The Reform Revolution Key Policy Changes in 1991
- Abolished mandatory licensing
- Opened previously closed sectors
- Allowed majority foreign ownership
- Created investment promotion board
- Simplified approval processes
Show Me the Money: Where Did FDI Flow?
By Sector (1990s)
- Engineering
- Chemicals
- Services
- Electronics
- Finance
- Computers
By Source Country (1995-99)
- Mauritius: 34%
- USA: 19%
- Japan: 7%
- Germany: 6%
- Netherlands: 5%
By State
- Top destinations: Maharashtra, Karnataka, Tamil Nadu, Gujarat
- Driven by: Infrastructure, business climate, tech hubs
What Really Drives FDI? The Evidence
The Major Factors
- Market Size
- GDP has huge positive impact
- 1% GDP increase → 11.65% FDI increase
- Economic Openness
- Strong positive relationship
- 1% increase in openness → 12% FDI increase
- Exchange Rate
- Depreciation discourages FDI
- High import costs hurt profitability
- Macroeconomic Stability
- Inflation, fiscal deficit, debt burden matter
- Stable fundamentals attract investment
Surprisingly Less Important
- Infrastructure development
- Market growth rate
- Domestic investment levels
Key Takeaways
For Policymakers
- Focus on expanding market size and openness
- Maintain stable exchange rate and macro fundamentals
- Address approval-to-actual FDI conversion gap
- Consider regional development impacts
For Businesses
- Market size offers huge potential
- Watch macroeconomic indicators
- Consider state-level factors
- Plan for import cost impacts
Looking Ahead The study suggests India’s FDI potential remains strong but requires:
- Continued policy reforms
- Infrastructure development
- Regional balance
- Streamlined processes
The data shows India’s 1991 reforms marked a clear turning point in attracting foreign investment. But realizing the full potential requires sustained focus on the fundamental drivers while addressing remaining barriers.
Academic Abstract:
This paper is an attempt to explain Foreign Direct Investment in India. It is observed that the liberalisation package of 1991 had a significant impact on the FDI flows into the country. The crucial determinants of FDI inflows in the Indian context are the absolute size of the domestic market, the exchange rate, openness of the economy, and a set of sound macroeconomic fundamentals. Therefore, to attract a critical quantum of FDI which can accelerate the growth process of the economy by bringing in more capital, technology, and market access, policy focus should be on the factors as noted above.
Learn More:
Full citation: K.G. Radhakrishnan and Jaya Prakash Pradhan (2000), ‘Foreign Direct Investment in India: Policy, Trends & Determinants’, Productivity, 41(3), pp.454–462, Publisher: National Productivity Council of India.
Learn More: