Introduction

One of the remarkable features of globalization in the 1990s was the flow of private capital in the form of foreign direct investment. FDI is an important source of development financing, and contributes to productivity gains by providing new investment, better technology, management expertise and export markets. Given resource constraints and lack of investment in developing countries, there has been increasing reliance on the market forces and private sector as the engine of economic growth. In the neoclassical growth model, FDI promotes economic growth by increasing the volume of investment and its efficiency. Therefore, all countries, particularly developing and least developed countries, seek to attract Foreign Direct Investment ¹ (FDI) for the package of benefits it brings along with it into the host country economy. Foreign investment, especially FDI, not only supplements domestic investment resources but also acts as a source of foreign exchange and can relax balance of payment constraints on growth. Considering the economic benefits and importance of FDI for promoting economic growth, most of the countries have formulated wide-reaching changes in national policies to attract FDI.

The empirical literature suggests that FDI raises national welfare by increasing the volume and efficiency of investment through improved competitiveness, technological diffusion, accelerated spillover effects and the accumulation of human capital (Borensztein et al. 1998; Chakrabati, 2001; Asicdu, 2002; Durham, 2004). Overall, the flow of FDI to developing countries contributes to growth through two mechanisms, i.e., increasing total investment in the host country and increasing productivity through technology and management spillover (Mellow, 1999).

The People's Republic of China (PRC) and East/Southeast Asian countries have made rapid improvement in their macroeconomic situations, investment, exports and employment over the decade of 1980s and 1990s through the use of large amounts of Foreign Direct Investment. Similarly private capital, which was long seen with concern and suspicion, is now regarded as source of investment and economic growth in South Asia. ² Like other developing countries, South Asian economies focus their investment incentives exclusively on foreign firms. Over the last two decades, market reforms, trade liberalization as well as more intense competition for FDI have led to reduced restrictions on foreign investment and expanded the scope for FDI in most sectors. However, the South Asian countries have been largely unsuccessful in attracting FDI. These countries, jointly and also individually, receive low FDI compared to PRC, Brazil, Singapore and other East/Southeast Asian countries. South Asia received the smallest FDI flows among developing Asian countries, accounting for around 3 percent of the total FDI inflows to developing countries in the region. All the countries in the South Asian region except India have received very little attention and negligible FDI inflows.

South Asian policymakers realize that credible efforts for economic reforms in South Asia must involve an upgrading of technology, scale of production and linkages to an increasingly integrated globalised production system chiefly through the participation of Multi National Corporations (MNCs). South Asian countries have many advantages to offer to potential investors, including high and steady economic growth, single-digit inflation, vast domestic markets, a growing number of skilled personnel, an increasing entrepreneurial class and constantly improving financial systems, including expanding capital markets. On top of these advantages, South Asian countries have been designing policies and giving incentives to foreign direct investment in several ways.

Recently, there has been lot of debate on the impact of FDI on economies. Critics of FDI argue that the MNCs bringing FDI generally monopolise resources, supplant domestic enterprises, introduce inappropriate technology and create balance of payments problems though large remittances. In this context, this study will examine the impact of FDI on economic growth, domestic investment and export in South Asian countries (India, Pakistan, Bangladesh, Sri Lanka and Nepal). The rest of the paper has been designed as follows: Section II explains macroeconomic reforms in South Asia; Section III analyses the FDI policy framework; Section IV includes an analysis of sources, trends, and patterns of FDI inflow to the South Asian region; and Section V empirically examines the impact and determinants of FDI in South Asia. Emphasis has been given on analysing the impact of infrastructure availability along with other potential factors on FDI inflow. This objective is important from the point of view of most South Asian countries, which lack infrastructure facilities.

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