FDI Inflow, Stock Market Performance and Exchange Rate: Indian Scenario

Abstract

In this research work, macro level analysis has been conducted to assess impact of foreign direct investment (FDI) capital inflow in Indian economy. This study is focused on causality relationship between FDI inflow, stock market performance and foreign exchange rate. This framework is used for policy implications of relationship between three variables. These macro-economic variables are linked with different policies. Causality tests performed on these variables are further used for policy implications. Impact of change in exchange rate on changes in FDI inflow is the least significant followed by impact of changes in FDI inflow on changes in sensitivity index of stock exchange (SENSEX). The third least significant relationship is observed between changes in FDI inflow on change in exchange rate. These relationships are implied to "Impossible Trinity" framework to assess preference for monetary, fiscal and foreign exchange rate policies. It is observed that improving performance of stock market (SENSEX) should be on priority followed by exchange rate. These finding have implications on fiscal policy, monetary policy and exchange rate. The increase in return of stock market and favourable exchange rate will help in increasing FDI inflow in Indian economy. Stock market performance depends on daily transactions by investors and they are regulated only, not controlled. Supply of foreign currency in India is controlled by the Reserve Bank of India (RBI), who assesses the supply conditions of the market and attempts to manage exchange rate in favour of Indian economy. In other words, the exchange rate can be controlled by having control on supply of foreign currency in domestic market. Hence, there is possibility of having fixed exchange rate and target band of exchange rate.