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Foreign Direct Investment (FDI) supports the national economic when it facing the lack of internal investment resources and it can cover the gap of investment resources and national investment. In this way, Foreign Direct Investment can affect the economic development and increase the speed of economic development. In this regards, among other countries, especially developing countries, that coped with the lack of internal financial resources have more interest to use Foreign Direct Investment. Since 1970 until now, the Foreign Direct Investment has been strongly growth and it outstrips from the trade growth and its causes to double exports of goods and services.
In other words, the Foreign investment in the developed world’s economy is development of transnational companies for improving competitiveness, higher profit, accessing to cheaper labor market and reaching a broader consumer market. Providing sufficient capital to finance investment is as one of the important factors in economic growth. In this regards, developing countries have tried to accumulation of capital through internal resources or by foreign direct investment to complete the deal. Also, foreign direct investment has a significant role in developing process in many countries.
Gross domestic product in Malaysia has the maximum growth rate comparing the other Association of Southeast Asian Nations and one of the remarkable strategies of the administration to encourage its growth is by create a center of attention to foreign direct investment. Malaysia is one of those developing countries that promote Foreign Direct Investment in order to increase speed growth and development. Foreign Direct Investment has cooperated a significant role in capital formation in Malaysia and the developing economy that has enhanced quickly.
Malaysia is one of the fastest country in growing economy in the Asia area with GNP growth of around eight plus percent per year. The Malaysian economy has shifted from agriculturally to further differentiate and also export oriented one after its independence in 1957. It is identified the Malaysian market is openly oriented with almost non existent non tariff blockade and averaging just about 50 percent and foreign exchange organize. Malaysian open trade is sustained by the two way trade approximately to 120 percent of Gross National Product (GNP). It has been demonstrated that from the established political environment, enhancing capita revenue, and the prospective for local integration all over the ASSOCIATION OF SOUTH EAST ASIAN NATIONS (ASEAN), Malaysia is a gorgeous view for FOREIGN DIRECT INVESTMENT (FDI) (see Graph 1.1). Foreign direct investment in Malaysia is a significant catalytic parameter, enhancing exports, awareness and offers an economic tool in the direction of the Malaysia 2020 vision.
Some empirical researches show that the economic growth has been established in the past 6 years at the above seven percent per year. In this regards the inflation rate has been remained below four percent, decreasing the unemployment rate, balancing the payments. Echange rate is as a significant factor in the Malaysian Foreign direct investment (FDI) in the general economy. Malaysian Bank Negara does not formally peg the Ringit (RM) to definite currencies and currency floats. In fact, Malaysian Bank Negara has been charged of depreciating the cost of the Ringit (RM) in order to encourage exports. On the other hand, Malaysia’s focus on Foreign direct investment, increasing exports, has provided it well and supplied to its 8 years of over 8 percent growth.
Foreign Direct investment (FDI)
Several definitions have been proposed for Foreign direct investment. The international monetary fund defines Foreign direct investment following: Foreign direct investment is a type of investment that to achieve sustainable benefits in the country except for the home country of investor and the investor’s objective is as an important role in the management of the organization (Bengoa and Blanca 2003). Foreign direct investment is considered dependable for enhanced well-being in the host country due to the benefits related to introduction of new innovations and technologies, improvement of extra abilities, enhances capital, improving work stations in host countries (Fizari, Asari et al. 2011). A study by Bengoa and Sanchez-Robles (2003), it is defined that Foreign direct investment is the most important contributor to the economic growth in the country. Foreign direct investment is considered as a significant resource of inflows in numerous countries, especially in emerging developing economies. In fact, Foreign direct investment is evidenced in the capital account of balance of payment (Chaudhary, Shah et al. 2012).
Foreign direct investment or FDI is the net inflows of venture to acquire a lasting management interest in an activity operating in an economy other than that of the investor. It is the sum of equity resources, other long term resources, short term resources and reinvestment of earning as illustrated in the balance of payments. Foreign direct investment in Malaysia is put on following the investment of at least 10 percent of the whole equity in a resident firm by a non-resident investor (Greenway 2004).
Economic growth is the enhance in the quantity of the services and goods manufactured by an economy over time. It is calculated as the percent rate of enhance in actual GDP (gross domestic product). Foreign direct investment has been a significant resource of economic growth in Malaysia, transporting in capital investment, management and technology knowledge necessitated for economic growth (Mun, Lin et al. 2008). In developing countries such as Malaysia, Foreign direct investment has a positive effect on economic growth and it also depend on some the other key factors, like: human capital base in host countries, the degree of openness in the economy (Lean 2008).
Carkovic and Levine (2002) found the positive effect of foreign direct investment in economic growth. Their finding showed that a country’s power to take benefit of Foreign direct asset externalities may be limited by local situation, like: the level of education in the country, the improvement of the local financial markets. Studies by (Durham 2004); (Hermes and Lensink 2003); (Alfaro, Chanda et al. 2004) presented support that just countries with well developed financial markets grow importantly from foreign direct investment in conditions of their growth rate. Wan (2010) argued that foreign direct investment can play a significant role in modernizing a national economy and encouraging economic growth.
On the other hand, the association among the exchange rate and economic growth is a significant issue, from the both a positive such as: descriptive and normative such as: policy prescription view (Ito, Isard et al. 1999). There are some countries that include explicitly or implicitly fixed their exchange rate to the currency of the other country such as: U.S. dollar and whose inflation rate are upper than that of the foreign country (U. S.) frequently practices persistent recent account deficits and eventual depressions of their currencies (Ito, Isard et al. 1999).
1.3. The role of Foreign direct investment and economic growth
Malaysia is one of the mainly open in the emerging world to foreign investment and it also distinguish the significant role that FDI can play in well placed for attracting investment in Malaysia (Kogid, Lily et al. 2010). Foreign direct investment is as a significant driver fundamental in the Malaysian powerful performance and also economic growth. There are numerous research that investigate the relationship between foreign direct investment and economic growth (Kogid, Lily et al. 2010).
There is an extensive view that the role of foreign direct investment (FDI) on economic growth is unclear (Greenway 2004; Azman-Saini, Law et al. 2010). One possible reason for this finding is picked up from the failure of model contingency achieves in the relationship between foreign direct investment and Growth. From the traditionally studies, the exchange rate had not composed a significant factor in the analysis of economic growth (Omankhanlen 2011).
Alfaro, Chanda et al. (2003) explored that countries with enhanced financial schemes can utilize foreign direct investment more efficiently and also foreign direct investment alone have an ambiguous role in causal to economic growth. Carkovic and Levine (2002) presented the positive role of foreign direct investment in generating economic growth, mainly in exacting environments. For instance, Borensztein, Gregorio et al. (1998) show that foreign direct investment has a positive growth outcome when the country has s extremely educated workforce that permits it to utilize foreign direct investment spillovers.
Exchange rate and inflation rate
There are various studies have seemed to the effect of exchange rate or inflation on direct investment (AHN, ADJI et al. 1998). Naturally, it identifies the negative effect of inflation by itself on direct investment. Exchange rate movements can affect foreign direct investment by affecting the current cost of gaining overseas (Froot and Stein 1991). For instance, a reduction in domestic currency value against foreign currency value of the domestic exchange rate will create it fewer expensive for foreign investor. In this regards, depreciation of the exchange rate will create inflows of foreign direct investment in that country rise (Erdal and Tatoglu 2002; Tsen 2006). There are some ways for controlling exchange rate, but it is so expensive. When the rate of interest is high, it avoids capital outflows obstruct growth of the economy and so it will hurt the country’s economy (Solnik 2000). According to Khalwaty (2000) There are some parameters that cause the exchange rate changes. Those parameters embrace: payments balance problems, changes in foreign exchange demand and supply, public revenue, changes the expectation, et al. Therefore, this study will explore the impact of inflation and exchange rate on foreign direct investment and economic growth.
Malaysia has a growing open economy. Malaysia had 29th level as the largest economy with GDP $357.9 billion in 2007 (Bank 2007). It is identified that foreign direct investment has been observed as a major driver underlying the strong growth performance occurrence by the Malaysian economy. Malaysia has got a substantial quantity of foreign direct investment in its industry over the past decades. Despite the significance of foreign direct investment (FDI) to the Malasia, there has been a little study the determinants of the foreign direct investment such as inflation and exchange rate. Most of the earlier researches use cross-sectional or panel data to find the determinants of foreign direct investment.
This study will examine two macroeconomic parameters, explicitly exchange rate and inflation, that effect on foreign direct investment and economic growth in Malaysia over a period from 1995 to 2009. Since the economic growth is one of the key determinants accountable for advanced foreign direct investment inflow (Fedderke and Romm 2006; Kiat 2008), this study want to examine foreign direct investment and its relation to economic growth. The aim of this study is to test whether any relationship between foreign direct investment and economic growth regarding its inflation and exchange rate. The relationship between foreign direct investment and economic growth is not clear in Malaysia. So, there is a need to carry out extra research on this relationship.
1.6. Research questions
On the basis of the above mentioned problem statement, the following research questions are suggested:
- RQ1: what is the effect of inflation on FDI and economic growth?
- RQ2: what is the effect of exchange rate on FDI and economic growth?
- RQ3: what is the effect of FDI on economic growth?
1.7. Research objectives
The objective of this thesis is to study the effect of inflation and exchange rate on FDI and its relation to economic growth in Malaysia from 1995 to 2009.
The objectives of this study are:
- RO1: To evaluate the effect of inflation on FDI and economic growth.
- RO2: To evaluate the effect of exchange rate on FDI and economic growth.
- RO3: To evaluate the effect of foreign direct investment on economic growth.
1.8. Theoretical framework
On the basis of the above mentioned literature, a research model is developed to examine the effect of the effect of inflation and exchange rate on FDI and its relation to economic growth in Malaysia (see Figure 1.1).
1.9. Scope of study
The study will focus on the influence of inflation and exchange rate on FDI in Malaysia. Malaysia is one of those developing countries that promote Foreign Direct Investment in order to increase speed growth and development. On the other hand, since, Foreign direct investment in Malaysia is a significant catalytic parameter, enhancing exports, awareness, thus it has a significant role in the economic growth of the country. And Malaysia has been encouraging FDI in its economic contribution.
1.10. Significant of study
Foreign direct investment has played a significant role in the capital formation and the economic development that has enhanced rapidly. Foreign direct investment offers a significant view in the course of which organizations can keep away from high production costs at home and discover gorgeous marketplace abroad (Demekas, Horvath et al. 2005; Utami and Inanga 2009; Yol and Teng 2009).
On the other hand Malaysia has been one of the majority successful Association of Southeast Asian Nations (ASEAN) countries in being a focus for FDI. In this regards, it is important to find a relationship between inflation, exchange rate and Foreign direct investment in Malaysia.
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