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Foreign investment refers to investments made by the residents of a country in the financial assets and production processes of another country. The effect of foreign investment, however, varies from country to country. It can affect the factor productivity of the recipient country and can also affect the balance of payments. Foreign investment provides a channel through which countries can gain access to foreign capital. It can come in two forms: FDI and foreign institutional investment (FII). Foreign direct investment involves in direct production activities and is also of a medium- to long-term nature. But foreign institutional investment is a short-term investment, mostly in the financial markets. FII, given its short-term nature, can have bidirectional causation with the returns of other domestic financial markets such as money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants of FII is very important for any emerging economy as FII exerts a larger impact on the domestic financial markets in the short run and a real impact in the long run. India, being a capital scarce country, has taken many measures to attract foreign investment since the beginning of reforms in 1991.

India is the second largest country in the world, with a population of over 1 billion people. As a developing country, India’s economy is characterized by wage rates that are significantly lower than those in most developed countries. These two traits combine to make India a natural destination for FDI and foreign institutional investment (FII). Until recently, however, India has attracted only a small share of global FDI and FII primarily due to government restrictions on foreign involvement in the economy. But beginning in 1991 and accelerating rapidly since 2000, India has liberalized its investment regulations and actively encouraged new foreign investment, a sharp reversal from decades of discouraging economic integration with the global economy.

The world is increasingly becoming interdependent. Goods and services followed by the financial transaction are moving across the borders. In fact, the world has become a borderless world. With the globalization of the various markets, international financial flows have so far been in excess for the goods and services among the trading countries of the world. Of the different types of financial inflows, the FDI and foreign institutional investment (FII)) has played an important role in the process of development of many economies. Further many developing countries consider FDI and FII as an important element in their development strategy among the various forms of foreign assistance.

The FDI and FII flows are usually preferred over the other form of external finance, because they are not debt creating, nonvolatile in nature and their returns depend upon the projects financed by the investor. The FDI and FII would also facilitate international trade and transfer of knowledge, skills and technology.

The FDI and FII is the process by which the resident of one country (the source country) acquire the ownership of assets for the purpose of controlling the production, distribution and other productive activities of a firm in another country(the host country).

According to the international monetary fund (IMF), FDI and FII is defined as “an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of investor”.

The government of India (GOI) has also recognized the key role of the FDI and FII in its process of economic development, not only as an addition to its own domestic capital but also as an important source of technology and other global...
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