Does domestic monetary policy affect foreign direct investment to India?

This paper employs the structural VAR methodology to empirically analyse how a domestic monetary policy shock affects foreign direct investment (FDI) to India. The paper uses two variables, interest rate differential and domestic money supply growth, as measures of domestic monetary policy shock to assess its impact on FDI flows. Empirical results reveal that interest rate differential is not a significant determinant of FDI flows to India, indicating that FDI flows are mainly driven by domestic fundamentals and the economy's growth potential. The results further reveal that domestic money supply growth has a positive and statistically significant impact on FDI flows. This suggests that while FDI flows to India are not affected by a change in interest rate differential, the central bank, using monetary policy, can influence FDI flows by managing domestic money supply growth. In particular, the central bank can attract greater FDI flows by increasing domestic money supply growth, which has a positive impact on ongoing domestic economic growth that creates an expectation of future GDP growth. Among other factors, domestic output growth is found to be the most important and significant determinant of FDI flows to India, followed by domestic infrastructure, domestic creditworthiness and domestic macroeconomic instability.