Development of Financial System and Foreign Direct Investment: A Study in Indian Perspective

Development of financial system is raison d’être for overall growth and development of the economy. Underdeveloped financial system acts as a fetter to attract sustained overseas investment in the form of Foreign Direct Investment. In this background, this paper attempts to investigate whether developed financial system is an important determinant of Foreign Direct Investment (FDI) in India. Using Vector Auto Regression (VAR) technique, the study aims to analyze the significant banking sector vis-a-vis capital market development variables that influenced FDI in India from 1980 to 2012. The results of the analysis leads to the conclusion that all the variables of capital market development, namely, market capitalization, stock traded and stock turnover are important determinants of FDI along with the positive impact of liberalization reforms initiated in 1991 suggesting irrefutable evidence of recommending robust foreign direct investment while at the same time streamlining the financial sector reforms. However, size of banking sector measured by liquid liabilities of banking sector and private sector credit by banking sector positively influence FDI.