Cos with larger FDI likely to have higher profitability: RBI

Larger foreign direct investment (FDI) receiving companies are likely to have higher profitability, a recent working paper published by the Reserve Bank of India (RBI) suggests.

Apart from the FDI share in equity, the size of the company and liquidity ratios also positively impact profitability, but the age of the company has a negative impact on the same, the paper says.

The study “Impact of Foreign Direct Investment on Profitability: Evidence from the Indian Corporate Sector” concludes that the share of FDI in equity is found to be negatively associated with the capital structure, which is captured by debt-to-equity ratio, long-term debt to total assets and short-term debt to total assets ratio. In other words, an increase in FDI results in a decrease in the leverage of the company, it states.

During the period 2013-14 to 2018-19 period, the share of long-term borrowings in total borrowings of these companies in the sample size of the study amplified from 64 per cent in 2013-14 to 70.6 per cent in 2018-19, the paper noted. The study analysed 2,275 FDI companies across all manufacturing and services sectors, which form about 25-30 per cent of companies in the RBI database. More than 80 per cent of companies had received FDI from ten countries -the US, Mauritius, Singapore, Japan, UK, Germany, Netherlands, Switzerland, and the United Arab Emirates – during this period.

“The size of the company is positively associated with profitability, suggesting that larger FDI-receiving companies are likely to have higher profitability; this finding is in line with the existing literature. This is because, in larger companies, the management is often more focused on preserving/improving its reputation, which helps in attracting greater FDI. Larger companies are better placed to take advantage of the increased FDI funding owing to the economies of scale and the cost-effective nature of their operations. And hence, FDI plays a greater role in enhancing the profitability of larger companies as compared to smaller companies,” the paper said.

“The tangibility of the company is negatively associated with both the return on assets and return on equity, possibly owing to higher depreciation and debt servicing pressures that may be associated with higher tangibility,” it adds.

The authors of the paper, Haridwar Yadav, Vishal Shinde and Samir Kumar Das, are from the Department of Statistics and Information Management of the RBI.