Do FDI Restrictions Impair Outward FDI? Evidence from Indian Firms

Driven by persistent scepticism about FDI, many countries adopt protectionist measures – regulatory restrictions being a key tool. This study argues that such restrictions hinder FDI, raising the key question: do FDI regulatory restrictions impede the flow of outward FDI (OFDI)? Building on Melitz-type heterogeneous firm models [Melitz, M. J. (2003). The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica, 71(6), 1695–1725; Helpman, E., Melitz, M. J., & Yeaple, S. R. (2004). Export versus FDI with heterogeneous firms. American economic review, 94(1), 300–316], the study examines how regulatory restriction influences Indian OFDI. Using firm-level bilateral data on Indian OFDI and the OECD's FDI regulatory restrictiveness index, the analysis reveals that OFDI does not respond uniformly to restrictions – equity limits, screening requirements, and personnel rules have varying effects. Additionally, a battery of heterogeneity checks is conducted to examine how foreign ownership decisions, sector-specific and cross-sectoral restrictions, and the North–South divide interact with regulatory barriers to influence OFDI. Results show that service-sector restrictions are particularly deterrent. The findings confirm strong sectoral complementarity and a pronounced North–South divide in regulatory sensitivity.