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Presented by:

Group B03

Introduction

The topic of this study is “Impact of trade openness on FDI in India”. Impact of trade openness on

FDI is and has been debatable. In the study we aim to examine the relationship between FDI and

trade openness over a period of 2002-2016 (15 years). This period can be called and era of strong

liberalization, it started from 1991 when the Indian economy was opened to world trade. We

examine not only the relationship between the two variables but also the impact of leading

macroeconomic variables on FDI. Here, for this study FDI is a dependent variable and others are to

be considered as independent variable. We have run Regression analysis using these variables and

multiple regression analysis by adding an independent variable in terms of financial development.

The analysis shows positive relation with good significance and growth in favourable direction in era

of strong liberalization. Let’s start by understanding key terms.

Trade openness

Trade openness is a measure of economic policies that either restrict or invite trade between

countries.

For example, if a country sets a policy of high trade tariffs, thus restricting the desirability of

international trade, this restrictive policy will inhibit other countries from sending exports and

accepting imports from that country. According to dominating economic theory, this restrictiveness,

this lack of trade openness, will have an economic effect of slowing economic development/growth.

Conversely, according to economic theory, trade openness will have an economic effect of

increasing economic development and growth.

FDI

A foreign direct investment (FDI) is an investment made by a firm or individual in one country into

business interests located in another country. Generally, FDI takes place when an investor

establishes foreign business operations or acquires foreign business assets in a foreign company.

However, FDIs are distinguished from portfolio investments in which an investor merely

purchases equities of foreign-based companies.

Recession

A recession is a macroeconomic term that refers to a significant decline in general economic activity

in a designated region. It is typically recognized after two consecutive quarters of economic decline,

as reflected by GDP in conjunction with monthly indicators like employment. Recessions are officially

declared in the U.S. by a committee of experts at the National Bureau of Economic Research (NBER),

who determines the peak and subsequent trough of the business cycle which demonstrates the

recession.

Problem Statement

Here we are trying investigate the relationship between FDI and trade openness and also to what

significance.

Objective

Our objective is to determine if a change in trade openness of the economy leads to a significant

change in FDI inflows in the economy.

Literature review

The impact of trade openness on FDI is controversial. Nations endeavour to attract more FDI

for a number of reasons relating to beliefs that FDI has a variety of positive e ffects such as

technology transfer, employee training, backward and forward linkages, labour mobility,

increased productivity, technical assistance and provision of access of local ﬁrms to

international markets. Many empirical studies advocate the arguments that FDI has a positive

impact on trade openness in recipient countries. In their study, Lane and Melesi-Ferretti (2001)

got the result that in growing countries, openness has a positive impact. Liargovas and Skandalis

tested 36 growing countries’ relationship between FDIs and openness between the years 1990-2008

using panel regression analysis and founded a positive and important relationship between

openness and the FDIs coming to the country. Hence, the transfer and adoption of relevant

technologies enhances productivity and helps countries to create labour-intensive

activities. The transfer of advanced technologies increases the demand of productive labour

and supports countries by enhancing labour generation activities besides training managers

and workers to increase their productivity in order to get long run beneﬁts from their

services. This would gene rate new jobs which might be seen as a short-run impact. It is

suggested that an increase in the demand plays a pivotal role in trade and the country’s

policy to support innovation, education and provision of infrastructural facilities.

It seems a paired effect in terms of FDI trade showing a robust relationship between FDI and

trade. Past experience provides an ample explanation that FDI promotes exports and helps local

ﬁrms to get access to global markets as well as operate efficiently by adopting new technologies

and try to be competitive, which highlights the value of economic freedom to attract FDI. Apergis

(2008) and conﬁrms that the cause and effect mechanism for exports. The major determinants of

foreign direct investment are trade openness, market size, labour force growth and infrastructure

growth. FDI also relies upon the rate of return that an investor receives from the host country.

Ashgar (2016) examined the relationship between FDI inﬂows and trade openness in South -

Asian economies. He examined the relationship of seven countries for the 1998 -2010 period

based on panel data using random effects estimation. Trade openness was measured by

three indicators, in terms of (Abdel Mahmoud Ibrahim Tahmad, n.d.) (Selahattin GÜRİŞ)

imports, exports and a joint combination of both factors. His results suggested that there is a

signiﬁcant relationship between trade openness and foreign direct investment inﬂows. Trade

openness has a positive and signiﬁcant impact on FDI inﬂows in South-Asian countries.

Methodology

The project has been conducted on the data set collected for the year 2002 to 2016. The data for

2017 and 2018 will be calculated using the regression equation which will be obtained after the

regression analysis has been performed.

Regression analysis

Regression analysis has been run on the data set on trade openness and FDI to set up the regression

model (after taking the natural logarithm)

Y= α + βX

For running the regression, the dependent variable Y= FDI and the independent variable X=Trade

openness.

After running the regression analysis in MS Excel below is the overall summary snapshot.

Where,

α= 15.32290914

β= 3.26144355619897

Hence it can be inferred that with 1% change of the Trade Openness the FDI will change by 3.26%

Using the above equation, the value of the FDI is calculated that gives us the predicted value of FDI

and then the difference of the observed value and predicted value is taken to get the residuals or

the error terms.

The below table provides the snapshot of the residuals for the given set of data.

A scatter plot of the observed and the predicted value of the regression has been captured in the

below snapshot.

25

24.5

24

FDI (ln)

23.5

23 FDI (ln)

22.5 Predicted FDI (ln)

22

21.5

0 0.5 1 1.5 2 2.5 3

Trade openess(ln)

R square 0.701307144647302 R square measures the strength of the regression. It can

be seen that the two variables are strongly correlated

with a strength of 70.13%

Multiple R 0.83744083053509 The value of multiple R signifies that the trade openness

and FDI are positively correlated. The same can be also

inferred from the above scatter plot.

Trend Forecasting

Trade openness in 2017 = 2.838904656

FDI = 3.261443556(2.838904656) + 15.32290914

= 24.58183644

Taking antilog,

FDI = 47397553010

Therefore, FDI in 2017 is forecasted to 47397553010

We can conclude that 4.483923812 increase in Trade openness would result in 2938981464 increase

in FDI

2) Assuming that in 2018, Trade openness increases by 12%

Trade openness in 2018 = 3.179573215

FDI = 3.261443556(3.179573215) + 15.32290914

= 25.69290771

Taking antilog,

FDI = 143975316700

Therefore, FDI in 2018 is forecasted to 143975316700

We can conclude that 6.939464798 increase in Trade openness would result in 96577763690

increase in FDI

3) Assuming that in 2019, Trade openness increases by 12%

Trade openness in 2019 = 3.561122001

FDI = 3.261443556(3.561122001) + 15.32290914

= 26.93730754

Taking antilog,

FDI = 499716882500

Therefore, FDI in 2018 is forecasted to 499716882500

We can conclude that 11.16617948 unit increase in Trade openness would result in 3.55742E+11

unit increase in FDI.

Hypothesis Testing

A T-test will be performed to check if the null hypothesis can be rejected or not using the below

decision-making rules.

Decision making

We will reject the null hypothesis if the value tcal > ttab at n-k degrees of freedom, else we accept the

null hypothesis.

Where n= No of observations

Since tcal > ttab at 13 degree of freedom and at 5% level of significance. Hence, we can reject the null

hypothesis.

Impact of trade openness and financial development on FDI inflow (Multiple

Regression Analysis)

As per the above analysis it has been seen that trade openness and FDI are significantly related. Now

to check if there has been any impact of financial developmet and trade openness together on the

FDI inflow to India, a multiple regression is performed on the data set.

To make the calculation easier the natural logarithm of the financial development is taken and

regression is run on MS Excel where,

Y= α + β1X1 + β2X2

Where,

α= the y-intercept

After running the multiple regression analysis below is the snapshot of the same.

Y= α + β1X1 + β2X2

α= 16.7342142743338

β1= 3.24045923946456

β2= 1.56808014496096

From the above equation it can be inferred that with 1% increase in trade openness, the FDI inflow

will increase by 3.24% keeping the financial development constant. On the other way, a 1% increase

in financial development will increase FDI inflow by 1.57% keeping the trade openness constant.

Now using the above equation, the predicted value of Y is calculated and residual error terms are

calculated. Below is the snapshot of the same.

Hypothesis Testing

H0: β0 = β1 = 0 or There is no significant relation between FDI, trade openness and financial

development.

H1: one or more β’s ≠ 0 or There is a relation between FDI, trade openness and financial

development

df = n-k

= 15-3 = 12

tcalc = 5.35140586204542

ttab = 2.179

tcalc > ttab at 5% level of significance at 12 degrees of freedom, we reject null hypothesis H0

tcalc = 0.627138716159004

ttab = 2.179

tcalc < ttab at 5% level of significance at 12 degrees of freedom, we accept null hypothesis H0

Implies there is no significant relation between FDI and financial development.

To study the impact of economic recession in the years 2008 and 2009, we have used dummy

variables where a year with recession is represented as 1 and year without a recession is

represented as 0.

The regression analysis is performed on above data and the below result is obtained

Multiple R = 0.850955 implies highly positive correlation between Trade openness, FDI and recession

Coefficients: α = 15.59361, β0 = 3.13636, β1 = 0.381049

AdjR2 (Coefficient of determination): 0.678 (We can say change in FDI has 67.8% variant for the

change in trade openness and recession)

H1: one or more β’s ≠ 0 or There is a relation between FDI, trade openness and D

df = n-k

= 15-3 = 12

tcalc = 5.195213

ttab = 2.179

tcalc = 0.996257

ttab = 2.179

Summary

Based on our analysis we conclude that for the given FDI and Trade openness data of past

15 years, there is a significant relationship between them in

Multiple regression analysis

Seasonal variation using dummy variable

Level of significance 5%

The null hypothesis is valid when we consider the relationship between FDI and recession,

hence the FDI is not significantly affected by recession under given consideration.

Alternative hypothesis (H1): There is relationship between trade openness and FDI

Null hypothesis (H0): No relationship between trade openness, financial development and FDI

Alternative hypothesis (H1) (for multiple regression): There is relationship between trade openness, financial

development and FDI

Null hypothesis (H0): There is no relationship between trade openness, recession and FDI

Alternative hypothesis (H1) (for Dummy): There is relationship between trade openness, recession and FDI

t –cal (trade

Equation Df R2 openness) t - tabular Hypothesis

Simple regression

F=α + β*T 13 0.710786 5.1952 2.179 Reject H0

Multiple

regression F=α + β1*T + β2*T 12 0.662583898 5.3514 2.179 Reject H0

Dummy Variable

F=α + β1*T + β2*T 12 0.724125 0.9962 2.179 Accept H0

References

-https://www.enotes.com/homework-help/what-trade-openness-87695

-http://www.usc.es/economet/journals1/aeid/aeid1524.pdf

https://www.researchgate.net/publication/330376635_The_impact_of_trade_openness_on_foreign

_direct_investment_in_Sudan_by_sector_in_the_1990-2017_period_An_empirical_analysis

- https://www.investopedia.com/terms/r/recession.asp

- https://www.investopedia.com/terms/f/fdi.asp

- https://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?vid=3&sid=8d87e9fe-be6e-44ee-9570-

2e8da132712c%40sessionmgr4007

- https://www.youtube.com/watch?v=PhL1rZp66AA

- https://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?vid=6&sid=8d87e9fe-be6e-44ee-9570-

2e8da132712c%40sessionmgr4007

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