FOREIGN DIRECTINVESTMENT(FDI) & INDIAN BANKING SECTOR

The effect of foreign direct investment on the domestic economy has been widely debated in literature, but a consensus opinion has not emerged. Critics have attributed the Asian banking crisis to the growth of foreign direct investment following the liberalization of foreign investment restrictions. Generally, the argument runs that foreign investors create a destabilizing influence on stock prices. Stiglitz (1998) posits that unregulated capital flows render developing economies more vulnerable to fluctuations in supply of international capital. According to Dornbusch and Park (1995), foreign investors tend to follow positive feedback strategies which cause markets to overreact to fundamental changes in value. Radelet and Sachs (1998) attribute the Asian financial crisis to financial panic. Hamann (1999) concludes that currency crises lead to financial crises: collapse in exchange rates lead to the collapse of banks that underestimate exchange rate risk and accumulate vast currency reserves. Several other researchers including Delhaise (1998) blame the Asian crisis on overgenerous and indiscreet lending by banks, especially western banks, and then switching to overly strict lending policies when market turned sour. Kim and Singal (2000) characterize “movement of hot money” as a major concern with policy makers in developing nations. Hot money investment is highly sensitive to interest rate and future growth expectations, such that adverse changes in these factors result in large changes in international flow of capital which exacerbates the shock, destabilizing the economy. The authors further point out that when markets are integrated, excess volatility in the foreign market