Absorptive capacities, FDI and economic growth in a developing economy: a study in the Indian context

Abstract

PurposeThe purpose of the study is to examine the moderating impact of absorptive capacity on the foreign direct investment (FDI)–growth link using the data for the period 1995–2019.Design/methodology/approachThe authors apply the autoregressive distributed lag (ARDL) model and threshold analysis for empirical analysis.FindingsThe findings indicate that the link between FDI and economic growth is influenced indirectly by absorptive capacities, such as financial development, institutional quality, technological capability, and trade openness. However, while examining the linear FDI–growth nexus, the authors noticed that human capital and infrastructure did not affect the relationship; when the non-linearity in the link is considered, the authors noted that all absorptive capacities (including human capital and infrastructure), when interacted with FDI, have a positive effect on growth. Furthermore, FDI stimulates growth if the absorptive capacities have exceeded a certain threshold level.Research limitations/implicationsFrom a practical standpoint, it is reasonable to conclude that improving absorptive capacities is critical in order to perceive FDI as a growth driver.Originality/valueIndia has been able to position itself as a preferred destination for FDI (when the major economies are facing a sharp decline in FDI inflows) despite the Covid-19 pandemic. However, it still suffers from low growth. Although much of the literature admits that absorptive capacity is crucial for FDI to promote growth, no study in the case of India examines FDI–growth nexus conditioned upon absorptive capacity. Moreover, the authors have used threshold analysis for assessing the non-linearities in FDI–growth nexus contingent on absorptive capacity.