Variables Which Determine Flow Of Fdi In Pakistan Finance Essay
Significance of the study
The significance of the study is to discuss those variables which determine the flow of FDI in Pakistan during Musharraf period. There have been lot of studies done in the past and various implications have been made in order to gauge the effect of different variables on Foreign Investment. The significance of this study is that it also describes different trends in FDI during Musharraf period and has also explained some of the variables which play a key role in attracting Foreign Investment during this period. It also explains benefits of foreign investment to the host country and also to Multi-national companies and foreign investors.
These are some of the objectives of this research:
Discuss the importance and benefits of Foreign Direct Investment flow for Pakistan.
What are the Factors which determine the flow of Foreign Direct Investment in Pakistan?
Demonstrate the relationship between these factors and Foreign Direct Investment in Pakistan
Discuss the Trends and flow of FDI showing the change in FDI during the period of Musharraf (1998-2007).
How these factors affect FDI flow in Pakistan.
Background of the problem
FDI have been one of the important factors which accelerate economic growth. In recent years, it has gained more importance due to its positive spillover effect on the economy of a country. There have been lots of studies done in order to investigate the potential determinants of FDI in recent years. Most of the developing countries have succeeded in getting a great deal of attraction from foreign investors due to their growth potential and scarce availability of resources. Pakistan is one of those countries who have enough natural resources but it lack required expertise in those fields. So, FDI have provided solution to that problem as due to flow of FDI, a country can become self-sufficient in technology and new innovations takes place. It is difficult to determine potential determinants of FDI in a particular region as these determinants keep on varying in different geographical territories and also by time. In case of Pakistan, there were lot of studies done from period of 1980- 2000. A lot of literatures have been written on FDI flow but findings of most of the studies contradict with each other due to difference of opinion and also difference of overall impact of these variables on FDI.
There are some important limitations with this study which includes:
This study is limited to small sample size i.e., 10 years of Musharraf Era (1998-2007).
Study is done solely on some of the determinants of FDI in case of Pakistan but help is also taken from literature written on other countries.
Only limited numbers of variables are taken into consideration due to inconsistency and unavailability of data for different variables.
Only reliable sources like World data bank website are used to gather secondary data.
Two dummy variables have been used in this study due to unavailability of data for these variables and their findings are based on previous studies.
There was very limited time for this study and resources provided were also very limited.
Fixed Capital Formation
Foreign Direct Investment
There is no significant relationship between inflation and foreign direct investment.
There is a significant relationship between inflation and foreign direct investment.
There is no significant relationship between exchange rate and foreign direct investment.
There is a significant relationship between exchange rate and foreign direct investment.
There is no significant relationship between trade openness and foreign direct investment.
There is a significant relationship between trade openness and foreign direct investment.
There is no significant relationship between fixed capital formation and foreign direct investment.
There is a significant relationship between fixed capital formation and foreign direct investment.
There is no significant relationship between stock exchange and foreign direct investment.
There is a significant relationship between stock exchange and foreign direct investment.
There is no significant relationship between privatization and foreign direct investment.
There is a significant relationship between privatization and foreign direct investment.
Foreign Direct investment is the investment done by foreign investors in a given country for a specified period of time. There may be lot of motives behind doing investment in a country by foreign investors or multi-national companies. These motives can be the availability of low cost labor, cheap resources and it can also be monetary benefits on long-term basis. FDI has gained a significant importance in recent years and different countries are making positive moves and paying a lot of attention to get benefits from it. Especially, after 1980’s there has been a positive trend toward this kind of investment because of its importance and benefits. Mostly developing countries have been successful in attracting major chunk of FDI. The major reason is that these countries have a greater potential for growth. A lot of policies and strategies are set up and followed by different countries to become an attracting place for foreign investors.
There are lots of determinants of FDI who always remain a key concern for policy makers and countries try to control those factors which have affect on FDI inflow. Among the key determinants of FDI are Trade Openness, Stock exchange, interest rate, privatization, infrastructure, exchange rate and fixed capital formation. These variables play an important role in determining the overall inflow of FDI for a country. Every country have its own factors for attracting foreign direct investment and the impact of these variables keep on changing from country to country. A lot of studies have been done to find out the key determinants of FDI for different countries and these studies have shown that role of a variable keeps on changing from one country to another and also its influence may change from time. So, it is very difficult to highlight those variables whose impact on FDI has remained consistent.
Recent studies have shown that inflation have a negative effect on the flow of FDI into a country. Infrastructure has positive relationship with FDI because if there is tremendous amount of progress take place in a country then obviously foreign investors will show keen interest to invest in that country and recent studies have also shown a positive relation in this regard. Exchange rate has also positive relationship because if the value of currency of any country A is better than other country B, then investors from country B will start investing in country A because in this way they will be getting good return as compared to country B. Capital formation which is the increased amount of investment done in business sector rather than saving. This will also promote the business culture within a country and outside investors will seek it as an opportunity and will start investing. Openness of trade and removal of trade barriers will absolutely encourage foreign investors to invest in that particular country.
Looking at the perspective of Pakistan, there has been huge amount of foreign direct investment done in recent years. Especially, in the Era of Musharraf there was a significant improvement in the overall foreign investment in the country. FDI have gained significant importance in recent years especially in developing countries like Pakistan which are rich in resources but due to lack of expertise and qualified labor, it have failed to get benefits out of its natural resources. FDI have solved this problem as with increased amount of foreign investment in Pakistan, it have helped in getting new technology and through innovativeness new products are brought into the market which have indeed broaden the overall scope of competition as well as helped in getting use to of better facilities.
Demirhan et al (2008), in his study “ Determinants of Foreign Direct Investment Flows to Developing countries: A cross Sectional Analysis” have explained that why countries need Foreign Direct Investment and what are different means through which they make it possible to have a sustainable flow of Foreign Direct Investment. In this study author had taken different variables and had done a cross-sectional study to measure the effect of all these variables on the possible inward or outward flow of FDI.
He have taken six different variables and have concluded that a suitable expanding market size, an open environment for trade free of different tariffs and duties and a country who have a strong infrastructure will be successful in attracting a great deal of investment from firms and multinational companies who want and are willing to invest in countries which have all these factors in abundance. Relationship of other variables like inflation and tax rate in a country with FDI is not positive because inflation and large tax rates within a country will discourage FDI and those companies and firms who want to invest within a country will always look for such markets where they have to pay less in the form of taxes in order to avoid extra expenses and costs. Secondly, there is a great chance that such government who promote free trade and try to attract big giants in the market through better policies will indeed succeed in attracting huge amount of Foreign Direct Investment.
Author had also taken into consideration a wide array of studies and theories of other authors in order to capture a true picture of factors which are basically the best in determining the amount of FDI in a country because there is a great controversy in these all variables. These Determinants of FDI are not the same in every country. There is a possibility that a variable may positively affect the FDI in a country and it may have a negative connection with FDI. Another point is that the relationship between FDI and any other variable may keep on changing by time to time. So, in order to take make the investigation more pure the author have done a lot of working.
In this study, author have taken thirty eight different developing countries because developing countries are more successful in attracting FDI than other less developed countries because they have more potential than other countries and developed countries have more concern in investing in other countries rather than attracting inward flow. There are also great deals of different threats which possibly exist in a country and they may act as the major hurdle in attracting FDI like different kind of political risks. Previous record or previous growth trend of a country may have a great deal of importance because many companies may look at the previous performance of other companies in a given country over a period of time and then they can decide whether to invest in that very country or not.
There are different levels of investment in a country, many companies may want to invest in other countries to capitalize the major chunk of the market of that country or they want to use those resources which are not available abundantly in the host country or which may be very expensive in that country. So, looking at the possible reasons, companies decide to invest in different countries and determinants of FDI play a vital and key role in making this decision.
Azam et al (2008), in his study “Determinants of Foreign Direct Investment in India, Indonesia and Pakistan: A Quantitative Approach” have said that foreign direct investment is dependent on a lot of different variables and a lot of factors determine the flow of FDI. In this study the author had taken three different countries from Asia and through regression have find out that there are a lot of factors like Market size and the condition of infrastructure and political condition within a country have a great deal of impact on FDI. There are a lot of factors which are very similar in case of Pakistan and India. The reason for this similarity may be that both countries have a lot of cultural and geographical similarities. But in the case of Indonesia, it has no such similarity with these two countries. The result finding and factors which affect FDI are pretty much similar to each other in India and Pakistan but differ a great deal between these countries and Indonesia.
Foreign Direct Investment have many advantages as it bring new technological advancements and with the arrival of different companies in a country may also help in availability of low cost products and companies operating in other countries may invest in other countries to get cheap resources and cheap labor can also attract huge amount of FDI or the motive behind investing in other countries may be to get advantage of taxes and subsidies, but at the same time it may not be seen a good move toward inward FDI by many companies and groups who are operating locally because it will result in immense competition between companies by the arrival of new and strong companies.
The author have taken the data for more than thirty years for all three countries and have also given a very brief and organized recap of FDI inflow in recent years in these countries. In recent years the figure of FDI have doubled with the passage of one year in India and Pakistan and the reason may be that these two countries due to their rapid development in recent years may have succeed in attaining the attention of many multinational companies. While, in Indonesia this flow is quite different from these two countries.
In order to gauge the relationship between different variables and that of FDI, the author have used regression analysis along with ordinary least square method and had also used log form because the data is not in a consistent form. There are wide ranges of software available for doing the regression but in this scenario the author has used E-view. Results in the case of Pakistan show that almost all the variables are statistically significant and some other variables like tax, government consumption and external debt have negative relation with FDI and are not significant.
Variables of India and Pakistan, which are the basic determinants if FDI flow are quite similar to each other except two variables but Indonesia scenario is completely different from both India and Pakistan. Talking as an overall perspective, we can say that a country that have political stability and their tax policies for investors are quite attracting will indeed attract a huge amount of FDI. Secondly, a country that has a great market potential and taking good measures in filling those gaps which are seen as a hurdle in the way of foreign investment will obviously have a great scope and will succeed in getting a huge proportion of FDI.
Shahbaz et al (2008), in his study “Direct Foreign investment and Income distribution: A Case Study for Pakistan” have said that there are a lot of factors which are determinants of FDI and are also very good factors which can also promote income equality. In this paper the author has discussed most of the factors which can have possible positive effect on FDI but they make the income equality situation of Pakistan more worsen. So, both FDI and income equality are discussed side by side in this paper.
This study is quite interesting from others because in it the author have taken a lot of Macroeconomic variables into account and have also used new techniques and measures in order to find the relationship between FDI and other variables. Talking about the perspective of Pakistan, an increased amount of FDI inflow will have a inverse impact on income equality and it will worsen the situation because most of the investment will be done in rural sector and more skilled labor will got more benefits from it. But in the case of Pakistan, the situation is quite different because most of the population is residing in urban areas and are less skilled. So, the incoming FDI will hence make the situation more unbalance by making one side more strong and leaving other at an edge. Similarly, more trade will help rich people more than poor and indeed will have negative impact on income distribution. This shows that there are also lots of disadvantages of increased FDI in Pakistan. But one thing i.e., foreign investment in agricultural activities will hence benefit the poor lot of Pakistan and in this way the income inequality can be decreased and most of the economists think that it is the best way to reduce poverty and bring prosperity in a country but for this purpose they have to take into consideration the factors are discussed before and unskilled labors along with more investment in agricultural sector will indeed make this happen.
FDI can also be seen as a great tool through which we can reduce unemployment and it helps a great deal in bringing economic stability in Pakistan. Another big advantage of FDI can be seen as that it will help in making the labor class of any country equipped with more skills as more competition will emerge due to foreign investment flow and new technology will come into the country which can produce better results. Through FDI, a huge lot of workers who are sitting idle for a long time can be used in a more suitable manner and their skills can be better polished. Similarly, there should be an equality between the allocation of foreign investment because it may trigger positivity but at the same time it also have negative impact if the total allocation is only inclined toward the big cities and toward the rich elite class. This will indeed worsen the income equality situation of a country as poor and backward areas that are ignored will hence become more and more backward.
Another big issue in the case of Pakistan is that most of the population of Pakistan is residing in villages and their most of the livelihood comes from farming and agriculture and much proportion is illiterate. Along with all these things, the rural population is not much aware of the outcomes and importance of FDI. These factors must also be accommodated in order to get the maximum benefits from FDI. So, all these factors are discussed in this study which makes it more interesting and different from all the other researches done in this particular field.
Another distinguishing factor in this paper is that the log-linear functional form has been used in doing the regression because through lot of previous studies and work it is found that it is much better than the linear form. The results findings have shown that in case of Pakistan some variables which do play a significant role in attracting FDI are much seen as having no such impact on FDI like that of trade openness. High inflation rate is a good indicator of income equality and it has shown some interesting implications in the case of Pakistan.
Alfaro et al (2004), in his study “FDI and economic growth: the role of local financial markets” have said that FDI plays a significant role in the overall economic growth of a country and secondly, those countries which have their financial markets well established can also gain better fruits in the form of greater FDI toward these countries. The author have taken data of twenty years and from various countries for the factors which effect FDI along with market capitalization which is the major factor in determining the impact of stock market in attracting FDI. FDI of more than thirty countries has been taken and an overall picture of influence of FDI on economic growth as well as trends and factors which are responsible for inward flow of FDI has been discussed. Another interesting finding in this paper is that most of the FDI or what we say foreign investment is done solely in private sector of most of the developing countries and reason for it is that developing countries show more interest and potential for foreign investors and they see it as beneficial for them because it will indeed shower some positive results and new technology will come into play and most interesting thing is that it will accelerate economic development along with making use of country's skilled labor and resources which have not yet been used.
Financial markets do play a key role in attracting foreign investors and if these markets are well established and are in good form than obviously there are more chances that it will make it more convenient for foreign investors to invest in that country. Financial markets can also provide a wide range of benefits to the potential investors.
Financial markets can also deal as intermediary between government agencies who want foreign investment and investors from other country who want to invest within a particular country. It also helps poor performing companies to form mergers with good performing foreign companies and foreign investors may acquire those companies who are not performing well by acting as an intermediary. The important role of FDI is for new emerging companies who have potential for future growth but they do not have sufficient cash to meet their goals. So, in this case the role of foreign investment came into play.
It can also be seen that there is a dual contribution of FDI, i.e., it also helps the host country to get benefits and also to multinationals that they can expand their production and most importantly the economies of scale can also be achieved through better allocation.
It is also seen that financial markets have a great deal of importance in attracting FDI because if the financial markets are not developed and are not up to the standards than there is a great chance that a country may not be able to take advantages from FDI or it may not be able to attract significant amount of FDI even though it have all the necessary things that are required for getting better FDI.
Azam (2008), in his study “Economic Determinants of Foreign Direct Investment in Armania, Kyrgya Republic and Turkmenistan: Theory and Evidence” have said that there are many factors which effect and determine the flow of FDI. In this paper the author have taken different variables for three different countries from Asia and have taken data for twenty years in log form. The paper has examined different factors which come into play and act as a ladder for FDI. Many factors needed to be controlled in order to boost the overall flow of FDI and at the same time there are some factors which encourage FDI.
Foreign Direct Investment can also act as an intermediary between different countries in a way that it promotes the flow of information, technology and different resources among countries and hence it is of great importance for the economic growth of countries. FDI can attract both physical capital and non physical capital in the form of loans, cash and capital investment in different ways.
There are lots of advantages of FDI flow as it can help in allocating potential savings in the best possible manner and it can also play a key role in bringing technological advancements and new ways of doing business into an economy. Returns and benefits of FDI are not subject to many crises because most of the investment is done for long period of time and investors invest on long-term basis rather than short-term and hence its benefits are more inclined towards future rather than timely basis.
The studies have shown that as FDI have some disadvantages for any given country, it also gives at least equal or more benefits which basically cancel the overall negative effect of FDI and generated more positivity for a country. A country that attracts great proportion if FDI may get negative results for the time being but will obviously get positive results as FDI is more subjected toward giving long-term results.
In this study, the author has taken data from thirty six countries and has found that some factors such as inflation have inverse relation with FDI as an increase in inflation will tend to discourage potential investors from investing in particular country and they start investing in those markets or countries that have basically lower inflation rate. Similarly, an increase in interest rate will obviously attract foreign investors to invest in a particular country as they will get more profits and more benefits from an increase in interest rate as compared to a country who have low interest rate.
In this study, the author has taken data of central Asian countries as in previous studies these countries are not taken into consideration. Secondly, some other interesting factors such as ODA are taken as it also is a major determinant of a positive flow of FDI into a country.
In the case of Armenia, some important economic variables such as the money brought by foreign residents and the total goods and services which are exported to other countries are reported in very less amount which has pushed the country into a bit worse situation and also there is very less efforts done in agricultural sector. Whereas the situation is totally different in the case of Kyrgyz Republic and Turkmenistan because a substantial growth has been achieved in agricultural sector and worker's remittance is quite impressive.
Kalotay et al (2000), in his study “Privatization and FDI in central and Eastern Europe” Said that both privatization and FDI are closely linked together. Policies and regulations of a country are well determining factors of the extent to which there will be total inflow of FDI in a country. A good privatization policy is also seems as a big factor which accelerate FDI inflow.
In this paper, the basic emphasis is to get in-depth of the areas where these two factors i.e., FDI and Privatization combine. When a lot of local companies and projects are owned by foreign investors then the state between FDI and privatization will take place and in recent years as we can see that there is huge amount of privatization done in the world and at the same time countries have taken full advantages from FDI and privatization at the same time. Especially, after 1990’s there are a huge amount of privatization that have took place through FDI inflows. As the governments have changed privatization policies for their countries, we can see that FDI flow also fluctuates and this dynamic FDI flow is also a determinant of extent of privatization in a country.
At the initial stage of privatization, there may not be much inflow of FDI as most of the investors may not be interested in investing in that newly privatized firm or company due to risks involved in investing it but with the passage of time it is seen that the FDI starts triggering. There can be some chances that some governmental and political forces may become hurdle in the way of foreign investors at the starting but somehow with the passage of time privatization starts making FDI flow toward particular country.
It also depends on the nature and willingness of investors that in which sector whey want to invest and maybe it is of no use to privatize those companies which have no interest for foreign investors. So, while making policies it is better to consider the perspective of foreign investors and also to keep on view the trends in the market. Privatization also bring some drastically changes along with it in the inner environment of the company as well the outer. Companies have to adopt new strategies and well as new policies are formulated with privatization and in some circumstances privatization changes the whole scenario of a company and a totally new thing come up in the market with even new product. So, privatization can also be seen as a change agent for some countries.
In this paper, the author through a survey have found key points regarding the privatization through FDI and has concluded that there is a huge improvements which have been seen after the privatization took place in most of the countries. Privatization has given much better results than that of before privatization era. Another key finding is that the performance and working of firm and its workers have also boosted a lot after the privatization. While there are also some factors which remains the same after and before the privatization.
There are also some areas in which there is not substantial improvement seen after the privatization i.e., research and development sector and secondly the net exports of the company have somehow decreased. But if we see it as overall, then we can see that after privatization companies have seen much more growth as compared to the period of pre-privatization. In recent years, there is a great trend seen toward privatization in most of the economies.
Giving as a concluding mark, I should say that from this paper it can be said that overall the privatization have a positive effect on overall inflow of FDI but it is of more important to keep in view the policies adopted by that country because these policies also reflect the potential growth pattern.
Cevis at el (2004), in his study “ The economic Determinants of Foreign Direct Investment in Developing countries and Transition Economies” said that during last decade there has been a drastic and a huge amount of investment done by foreign investors in developing countries and this trend have almost shown huge growth in most of the developing countries. In this paper, the author have tried to cover most of the variables and also have taken that very time period in which there has been huge increase in FDI flow especially in developing countries, so that we can get enough understanding of the topic.
FDI is of great importance for developing countries and there has been a huge shift in number of countries who got benefits from FDI and total amount of FDI has almost doubled in developing countries.
The reason behind this huge increase in the number of developing countries who got most of the FDI flow is that companies who are faced with intensive competition, they try to come up with new and competitive strategies and try to find out new and efficient ways for getting resources and labor in order to cut their cost. So, they view developing countries as more interesting and attracting alternative in this regard as compared to developed nations which charge them high costs and a large amount of taxes. So, we can say that in order to get competitive edge or to achieve economies of scale companies prefer to expand their businesses in those countries where there is cheap recourses and labor easily available. FDI is also very beneficial in a way that it also brings new technological advancements and new ways of doing business with it.
In this study, author has discussed those variables which are important in determining the overall impact of FDI and who are also a well determinant of the flow of FDI.
Availability and accessibility of most of the factors is very important in attracting foreign investors to invest in a country. For-example, availability of cheap labor and well developed infrastructure will provide a good platform for foreign investors. Secondly, an expanding market size will also show a positive sign toward positive inflow of FDI but it is not compulsory that these variables always show the same results or their effect remains the same. During the passage of time, their role and characteristics have shifted and changed according to the environment of a country. Most interesting factors which have been discussed in this paper and which also have negative impact on flow of FDI are also there and they needed to be controlled like corruption, governmental risks and different kind of policies which hinder foreign investors from investing.
Bishnu (2011), in his study “FDI, Trade Openness, Capital Formation, and Economic Growth in Bangladesh: A Linkage Analysis” said that said that there is a positive relationship between capital formation and FDI because due to an increase in FDI inflow into a country, there will be inflow of new and long-term capital with new technology and also increase in overall skills of management. And all these factors will in return boost the economy of a country.
Secondly, the more a country will promote free trade and encourage others to invest in that very country, this will also result in an increase in FDI inflow as more investors will invest in the country due to the potential benefits that they will see in that country.
Similarly, if there will be increased investment done in business sectors and more investment takes place instead of savings, then obviously there are more chances of economic growth and also when there will be more foreign investment done in business sector, it will result in increase in FDI.
Another very important thing discussed in this paper is that capital formation has positive relation with FDI in Bangladesh but it is also important to note that this relationship may not be the same in all countries. It keep on changing as I have also discussed earlier that all the variables which effect FDI positively may not have the same effect in other countries.
Secondly, if a country encourages foreign investors to invest in their business sectors and also encourages their businesses through giving tax exemptions will also result in an increase in FDI inflow. The case is same in the case of Bangladesh as in Eighties when the country starts to reap benefits through getting huge amount of FDI through its special government policies for foreign investors.
Narayanamurthy et al (2010), in his study “Determinants of FDI in BRICS Countries: A panel analysis” said that some of the emerging world powers in recent years like India and China from Asia, Russia and Brazil have shown a tremendous growth in recent years. We can also clearly see that there had been a huge amount of foreign investments done in these countries, new industries are set up and along with this these countries have also encouraged foreign investors by offering economies of scale and also due to a huge growth potential in these countries these countries have gained a huge FDI inflow from other countries.
Secondly, the results and benefits of FDI in these countries have also encouraged other countries to take active steps in this regard.
There are lot of factors which are also responsible for this huge FDI inflow amongst which capital formation, Free trade through reducing trade barriers and economies of scale through cheap labor and resources are the dominant one.
Similarly, if the market size of a country is larger than other countries than obviously that country will get more investment from foreign investors and that country will also have more growth potential than other countries. Secondly, if the value of currency of a country is better than any other country, than there are more chances that investors from a country where there is low exchange rate will start investing in country with higher exchange rate because in this way they will get more benefits. Another point is that if the overall investment climate within a country starts developing and the trend of investing shifts toward businesses from that of savings. This indeed will attract more FDI inflow. This will indeed encourages foreign investors to invest in that country and hence FDI inflow will start increasing. Along with this, if the infrastructure of a country is well developed and there is a sufficient amount of development done is this sectors, then obviously, this is a positive sign for that country and this will be like a green signal for foreign investors because a good infrastructure will show that this country has more growth potential and also willingness of that country among new development projects.
Muhammad et al (2010), in his study “A Nexus between Foreign Direct Investment &
Pakistan’s Economy” have taken different vairbles to see their impact on FDI and has found that trade openness and fixed capital formation are good variables which do affect the flow of FDI in Pakistan. He also found that some important variables like debt serving have no affect on FDI. In recent years, FDI have emerged as an important factor which boost growth of the host country. An important thing to keep in mind is that there is no such accurate measure of impact of FDI on economic growth but many studies have shown that FDI have great deal of role in bringing new technology and most of the economies of the world show much interest in FDI because it also helps in achieving economies of scale. Pakistan has a great potential to attract FDI especially in telecommunication sector and agricultural sector because these two sectors have shown huge amount of development in recent years and government have also taken many steps in promoting these sectors. Pakistan has also great potential to attract investment from foreign investors by offering incentives on tax policies and other benefits. Author have also used different statistical software and graphical analysis in order to capture a valid picture of trends in FDI over several years and how different variables affect FDI. The major contributors of FDI in Pakistan are UK and U.S and some countries of middle Asia, whereas the role of China is much towards the development of infrastructure.
In this study, Descriptive research design along with time series data from the period 1998-2007(Musharraf Era) has been taken. This research is based on secondary data and in order to explain the impact of Dummy variables on FDI, we have taken help from previous research findings. All the secondary data were obtained from World development indicators (WDI) and Global Development Finance website.
Data includes observations of market capitalization of listed companies for the stock exchange and fixed capital formation is taken. Values of both these are as percentage of GDP. Official Exchange rate and annual inflation rate, consumer price is also included in the data set. Trade openness is taken as Trade as a percentage of GDP. Trade is basically total imports plus total exports in a certain year. FDI is also taken as percentage of GDP.
In order to run regression to find out the relationship between dependent and independent variables, Stat graphics (which is statistical software) is used. Secondly, graphs are also used to explain the trend of FDI in recent years and also the relation between different variables is also explained through graphs. Whereas, previous findings of researchers are used in order to find the relationship between Dummy variables and FDI.
Multiple Regression - FDI
Dependent variable: FDI
Fixed capital formation
Fixed capital formation
Analysis of Variance
Sum of Squares
R-squared = 97.1359 percent
R-squared (adjusted for d.f.) = 93.5558 percent
Standard Error of Est. = 0.310395
Mean absolute error = 0.1561
Durbin-Watson statistic = 2.33862 (P=0.3946)
Lag 1 residual autocorrelation = -0.221178
FDI = -7.00755 + 0.111731*trade openness - 0.166054*Inflation + 0.216902*Fixed capital formation + 0.043436*stock exchange + 0.0165355*exchange rate
Looking at the table above, most of the variables have positive sign and are positively correlated with FDI and while comparing value of t-statistics of each variable with the t-critical which is 2.13, we can say that fixed capital formation, exchange rate and stock exchange are positively correlated with FDI and these variables are statistically significant at 10 percent level. Whereas, the value of other two variables is below t-critical showing that inflation and trade openness are not statistically significant at 10 percent level as their value are less than 2.13. In most of the studies done previously, trade openness have positive relationship with FDI whereas in this study which is from period 1998-2007, we can see that there is no such positive relationship between trade openness and Foreign Direct Investment.
From the previous studies done on dummy variables, it is stated that privatization done after 1990’s till Musharraf government also contributed to FDI. Privatization policies have gained attraction of foreign investors and new companies came into market showing significant improvement in foreign investment. There is a significant relationship between FDI and privatization. Secondly, previous studies have also shown that improvements have been made in infrastructure such as roads, railways and electricity. And these improvements in infrastructure have also helped in gaining attraction of foreign investors.
In this paper, different determinants of FDI are discussed with perspective of Pakistan during Musharraf Era. From the written literature and empirical results, we can conclude that increase in capital formation during Musharraf period have helped in attracting more FDI. Improvements in exchange rate have also attracted foreign investment. There have been some improvements done in stock exchange of Pakistan which in turn have helped foreign investors in getting reliable and important information about domestic company’s performance and this have indeed have attracted more FDI. Inflation rate have shown no such impact on foreign investment. Trade openness has no significant relationship because overall trade has remained same over the period. Privatization was another big reason for the attraction of foreign investment and remarkable improvements done in infrastructure also contributed to FDI.
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