Detecting causality between net FDI Inflows and GDP in India

This paper empirically examines the association and causality between GDP (Gross Domestic Product) and FDI (Foreign Direct Investment) net inflow in the Indian economy from 1979 to 2015. A variety of econometric toolsfor stationarity tests are employed including serial correlation, unit root tests of ADF, KPSS, and PP along with Zivot Andrews to test for any structural change in the series. To examine the existence of association, residual and system based cointegration tests are applied. For assessing the long and short run causality, vector error correction mechanism and granger causality tests are used. The results show that there is long run association between net FDI inflow and GDP. There also exists long run causality between them, however, in the short run GDP causes net FDI inflow and not vice versa. The presence of long run causation is empirically more sound for GDP led FDI instead of FDI led GDP. However, both GDP and FDI do not granger cause each other, they are not mutually reinforcing. The results have significant implications for policy development. The impact of FDI on GDP still needs to reach a consensus opinion to state whether there is more than association between the two.