Determinants of Inter-Country Variations in Outward Foreign Direct Investment and Cases of Outward FDI from India

Abstract

Existing literature offers the reasons for emergence of foreign direct investment (FDI) through various hypotheses. The intangible assets advantage hypothesis suggests that FDI occurs due to presence of a bundle of “intangible assets” or market imperfections (Kindleberger, 1969). The capital market imperfection theory (Aliber, 1993) argues that capital market relationships and exchange rate risk explain emergence of FDI. The O-L-I framework presented by Dunning combines the firm specific advantages and country specific advantages to explain the same. Extensive research has been done on inward foreign direct investment. However, the literature remains sparse for understanding outward foreign direct investment (OFDI). This thesis comprises of two essays on OFDI. The first essay focuses on cases of Indian companies. The second essay explores empirically, the determinants behind the emergence of OFDI from economies.

Essay 1: Cases of Outward FDI from India This essay attempts to explore the international foray of seven Indian companies. It aims to identify the motivation behind the global foray. These companies are Coal India, ONGC, Biocon, Bharat Forge Ltd., Thermax India Ltd., Aurobindo Pharma and Karuturi Global Ltd. Each case uses the eclectic O-L-I framework proposed by Dunning. Further, it attempts to look at the Indian OFDI patterns and compare across and within the categories. The study uses a longitudinal case-study method to capture the internationalization patterns. The approach adopted is to analyze overseas deals in detail and map the rationale of each with the existing economic theory. The study further seeks to find whether O-L-I framework is comprehensive enough to capture the internationalization journey of these companies or not. The information is derived from the annual reports of the company, published works, government documents, organizational report , archived documents, corporate reports (including website), newspaper and magazines and other case studies (if any).The findings of the study have been validated by conducting interviews with the managers of respective companies.

The strength of the study is that instead of looking at the overall OFDI of the company, it analyses the rationale behind each deal and evaluates how the motivation has changed overtime. Further, it applies the economic literature effectively to understand the pattern of internationalization journey of company and extracts the specifics for proposing extensions to the existing literature.

The main contribution of the study is concretization of the O-L-I framework in the current context by looking at the phenomenon of OFDI as a dynamic event affected by the past, future and present conditions arising out of economies of internationalization. This dynamic aspect of OFDI is not captured by the O-L-I model. This study contributes to the current literature by adding this dimension.

Essay 2: Determinants of Inter-country Variations in OFDI This study analyzes the relationship between outward foreign direct investment (OFDI) stocks pertaining to thirty four source and one hundred and sixty destination countries and other various variables such as size, distance, common language etc. The data from a variety of sources: IMF, UNCTAD, WDI, Penn Tables have been used. We augment the usual gravity model to allow for the gravity model to distinguish between GDPs constituted by per capita income and population.In all the estimation models, a gravity model is embedded. The variables from economic theories both competing and complementary are introduced to take the analysis further. The main finding is that the gravity model explains a large part of the variation in outward FDI. The gravity model allows for the “normalization of OFDI stocks” more completely than has been in general use in the literature. The variables derived from economic theory, whether the mainstream OLI framework or the finance theory of Aliber (1970), to the extent that these could be marshaled at the country level, have in relation to the gravity model, much less explanatory power. Analysis of firms/ industries with outward FDI in the literature though grant significant explanatory power to variables derived from economic theory. This would suggest that economic theories of OFDI, quite like economic theories of trade have the power to explain, the composition and nature of FDI, but not the overall volumes of FDI, just as much as trade theories do not have the power to explain the volume of trade, but only of its composition and nature. Methodologically, it means that as much as in the case of trade, studies of country to country FDI ought to be properly conditioned through the augmented gravity model, whether or not the dataset is for a limited set of countries.

Our principal findings are as follows: (i). The variables of the gravity model (population size, per capita income and distance) explain nearly 50 per cent of the variation in the outward FDI stock. The coefficients are not only significant but are significantly close to the expected values. (ii). Common language and colonial linkages explain further variations in OFDI stock, over the gravity model (iii). Index of revealed comparative advantage of natural resources for source country bears positive relation with OFDI (iv).Common currency (Euro, in this study) between source and destination country lowers transaction costs and reduces risk in transactions between the source and destination countries to increase OFDI level. Overall, the gravity related variables have very large significance, and even if other variables are included their coefficients are unlikely to change. This study also provides a review of the immediate empirical studies and methodologies often used for modeling OFDI.