The Pattern of Inbound FDI in India in Dirty Sectors

Encouraging foreign direct investment inflow (FDI) has been an important development strategy for a capital-scarce economy like India. Systematic reforms and investment liberalization policies adopted since 1991 have substantially increased FDI in the manufacturing industry, especially since 2006. However, the sustained growth of FDI in polluting manufacturing industries as compared to the cleaner manufacturing raises question as to why FDI is coming into polluting industries in India after liberalization of investment policies. We address this question by first examining the composition of the FDI inflow by industry-specific characteristics (at disaggregated 3-digit industry classification) of the Indian manufacturing. Second, we analyze the FDI inflows by home country to examine different sources of comparative advantage that motivates investment in India from relatively high income countries, covering a 15-year period from 2000 through 2014. We find that there are many factors, other than environmental regulations, that play an important role in influencing the decision of foreign investors to invest in polluting industries in India. Analysis of aggregate FDI at the industry level reveals that FDI inflows in India is concentrated into capital intensive industries and in less-export oriented industries, while inflows in polluting industries is mostly into export oriented and less energy intensive industries. Country level analysis reveals that aggregate FDI in polluting industries and in specific polluting industries (such as drugs, metals, and Food processing) are sourced from capital abundant, large size countries and open economies.